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Econometrics I
Part 2 Projection and
Regression
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Statistical Relationship
Objective: Characterize the relationship
between a variable of interest and a set of
'related' variables
Context: An inverse demand equation,
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Conditional Moments
expectations)
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50 Observations on P and Q
Showing Variation of P Around E[P]
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EXPECTDY
1.40
1.05
.70
.35
.00
0
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g*(x)= 0 Kk 1 k (x k -E[x k ])
0 E[y]
Var[x ]}-1 {Cov[x ,y]}
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Representations of Y
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Summary
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Linearity
Simple linear model, E[y|x]=x
Quadratic model: E[y|x]= + 1x + 2x2
Loglinear model, E[lny|lnx]= + k lnxkk
Semilog, E[y|x]= + k lnxkk
Translog: E[lny|lnx]= + k lnxkk
+ (1/2) k l kl lnxk lnxl
All are linear. An infinite number of
variations.
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Linearity
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E[yN|x] = xN
All n observations at once: E[y|X] = X = E.
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Uniqueness of E[y|X]
Now, suppose there is a that produces the
same expected value,
E[y|X] = X = E.
Let = - . Then,
X = X - X = E - E = 0.
Is this possible? X is an NK matrix (N rows, K
columns). What does X = 0 mean? We
assume this is not possible. This is the full
rank assumption it is an identifiability
assumption. Ultimately, it will imply that we
can estimate . (We have yet to develop this.)
This requires N K .
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Linear Dependence
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3/49
The Persistence
of Econometrics
Greene, 2011
Why do larger
paintings command
higher prices?
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The Persistence of
Memory. Salvador
Dali, 1931
Notation
Define column vectors of n observations on y and the K variables.
y1 x11
y
x
2
21
y N xN1
x12
x22
xN2
x1K 1 1
x2 K 2 2
xNK K N
= X +
The assumption means that the rank of the matrix X is K.
No linear dependencies => FULL COLUMN RANK of the matrix X.
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E[|all data in X] = 0
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Normal Distribution of
An assumption of limited
usefulness
Temporary.
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Regression?
If E[y|X] = X then E[y|x] is also the projection.
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=
=
=
=
=
=
=
=
=
=
=
work experience
weeks worked
occupation, 1 if blue collar,
1 if manufacturing industry
1 if resides in south
1 if resides in a city (SMSA)
1 if married
1 if female
1 if wage set by union contract
years of education
log of wage = dependent variable in regressions
These data were analyzed in Cornwell, C. and Rupert, P., "Efficient Estimation with Panel
Data: An Empirical Comparison of Instrumental Variable Estimators," Journal of Applied
Econometrics, 3, 1988, pp. 149-155. See Baltagi, page 122 for further analysis. The
data were downloaded from the website for Baltagi's text.
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