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You are on page 1of 13

Chapter 3:

TWO-VARIABLE

REGRESSION MODEL:

The problem of Estimation

1

Prof. Himayatullah May 2004

3-1. The method of ordinary

least square (OLS)

Least-square criterion:

Minimizing U^2i = (Yi – Y^i) 2

= (Yi- ^1 - ^2X)2 (3.1.2)

Normal Equation and solving it

for ^1 and ^2 = Least-square

estimators [See (3.1.6)(3.1.7)]

Numerical and statistical

properties of OLS are as follows:

2

Prof. Himayatullah May 2004

3-1. The method of ordinary least

square (OLS)

OLS estimators are expressed solely in terms of

observable quantities. They are point estimators

The sample regression line passes through

sample means of X and Y

The mean value of the estimated Y^ is equal to

the mean value of the actual Y: E(Y) = E(Y^)

The mean value of the residuals U^i is zero:

E(u^i )=0

u^i are uncorrelated with the predicted Y^i and

with Xi : That are u^iY^i = 0; u^iXi = 0

3

Prof. Himayatullah May 2004

3-2. The assumptions underlying

the method of least squares

(in parameters)

Ass 2: X values are fixed in repeated

sampling

Ass 3: Zero mean value of ui : E(uiXi)=0

Ass 4: Homoscedasticity or equal

variance of ui : Var (uiXi) = 2

[VS. Heteroscedasticity]

Ass 5: No autocorrelation between the

disturbances: Cov(ui,ujXi,Xj ) = 0

with i # j [VS. Correlation, + or - ]

4

Prof. Himayatullah May 2004

3-2. The assumptions underlying

the method of least squares

Ass 6: Zero covariance between ui and Xi

Cov(ui, Xi) = E(ui, Xi) = 0

Ass 7: The number of observations n must be

greater than the number of parameters

to be estimated

Ass 8: Variability in X values. They must

not all be the same

Ass 9: The regression model is correctly

specified

Ass 10: There is no perfect multicollinearity

between Xs

5

Prof. Himayatullah May 2004

3-3. Precision or standard errors of

least-squares estimates

In statistics the precision of an

estimate is measured by its standard

error (SE)

var( ^2) = 2 / x2i (3.3.1)

se(^2) = Var(^2) (3.3.2)

var( ^1) = 2 X2i / n x2i (3.3.3)

se(^1) = Var(^1) (3.3.4)

^ 2 = u^2i / (n - 2) (3.3.5)

^ = ^ 2 is standard error of the

estimate 6

Prof. Himayatullah May 2004

3-3. Precision or standard errors of

least-squares estimates

+ var( ^2) is proportional to 2 and

inversely proportional to x2i

+ var( ^1) is proportional to 2 and

X2i but inversely proportional to x2i

and the sample size n.

+ cov ( ^1 , ^2) = -X var( ^2) shows

the independence between ^1 and ^2

7

Prof. Himayatullah May 2004

3-4. Properties of least-squares

estimators: The Gauss-Markov Theorem

An OLS estimator is said to be BLUE if :

+ It is linear, that is, a linear function of a

random variable, such as the dependent

variable Y in the regression model

+ It is unbiased , that is, its average or expected

value, E(^2), is equal to the true value 2

+ It has minimum variance in the class of all

such linear unbiased estimators

An unbiased estimator with the least variance is

known as an efficient estimator

8

Prof. Himayatullah May 2004

3-4. Properties of least-squares

estimators: The Gauss-Markov

Theorem

Given the assumptions of the

classical linear regression model,

the least-squares estimators, in

class of unbiased linear estimators,

have minimum variance, that is,

they are BLUE

9

Prof. Himayatullah May 2004

β̂ 2

r2: A measure of “Goodness of fit”

Yi = Ŷ i + Û i or

Yi - Y = Ŷ i - Ŷi + Ûi or

yi = ŷ i + Û i (Note: Y= Ŷ )

Squaring on both side and summing =>

yi2 = β̂22 x2i + Û 2i ; or

TSS = ESS + RSS

10

Prof. Himayatullah May 2004

3-5. The coefficient of determination r2:

A measure of “Goodness of fit”

ESS = Y^ i2 = ^22 x2i =

Explained Sum of Squares

RSS = u^2I = Residual Sum of

Squares

ESS RSS

1= -------- + -------- ; or

TSS TSS

RSS RSS

1= r2 + ------- ; or r2 = 1 - -------

TSS TSS 11

Prof. Himayatullah May 2004

3-5. The coefficient of determination r2:

A measure of “Goodness of fit”

r2 = ESS/TSS

is coefficient of determination, it measures

the proportion or percentage of the total

variation in Y explained by the regression

Model

0 r2 1;

r = r2 is sample correlation coefficient

Some properties of r

12

Prof. Himayatullah May 2004

3-5. The coefficient of determination r2:

A measure of “Goodness of fit”

3-7. Illustrative Examples (pages 83-85)

3-8. Coffee demand Function

3-9. Monte Carlo Experiments (page 85)

3-10. Summary and conclusions (pages

86-87)

13

Prof. Himayatullah May 2004

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