Applied Econometrics

Applied Econometrics
Simple Regression

Applied Econometrics
1. Introduction to the Classical Linear Regression
Model
2. The OLS Method of Estimation
3. The Overall Goodness of Fit
4. Hypothesis Testing
5. How to Estimate a Simple Regression in EViews
6. Applications and Examples
Applied Econometrics
Compute the equation of a simple regression line
from sample of data, and interpret the slope and
intercept of the equation.
Full understanding of the simple OLS method of
estimation and discussion of properties of
estimated coefficients.
Computation of standard error of estimate and
interpretation of its meaning and use in Hypothesis
Testing.
Understanding and interpreting the R
2




Learning Objectives

Applied Econometrics
Introduction

Regression analysis is the process of constructing
a mathematical model or function that can be used to
predict or determine one variable by another
variable.
Key issue here is direction of causation of the two
variables, or which variable depends on the other.
Therefore we have two cases of variables:
dependent (usually denoted by Y)
independent or explanatory (usually denoted by X)

Applied Econometrics
Reasons behind the Existence of Disturbance/Error
term/Residual:
Omission of Explanatory Variables: There might be
other factors (other than Xt) affecting Yt. This may be
because we dont know or we exclude them even we know
because we might be unable to measure them.
Aggregation of Variables: To avoid having too many
variables and therefore we attempt to summarize in
aggregate a number of relationships in only one variable.
Model Misspecification: we might have a misspecified
model in terms of its structure. E.g. it might be Yt is not
affected by Xt, but it is affected by its previous value (Xt-1)
Applied Econometrics
Cont.
Functional Misspecification: The relationship
between X and Y might be non-linear. It also
become the reason of error term.
Measurement Errors: If the measurement of on
or more variables is not correct then errors
appear in the relationship and these contributes
to the disturbance term.
Applied Econometrics
The Scatter Plot
0
50
100
150
200
250
300
0 20 40 60 80 100 120 140 160 180
X
X
Applied Econometrics
Four Ways of Fitting a Line in the Data

By eye
Connecting the first with the last observation
Take the average of the first two and the
average of the two last and connect
Apply Ordinary Least Squares
Applied Econometrics
Derivation of Regression Models or OLS

Applied Econometrics
Example: The Keynesian
Consumption Function
Applied Econometrics
Example: Keynesian Consumption Function

C2=B2*A2
D2=B2*B2

A22=SUM(A2:A21)
B22=SUM(B2:B21)

and so on!
Applied Econometrics
Excel Calculations
b
0
=(C22-(A22*B22)/20)/(D22-((B222)/20))=0.601888903
b
1
=AVERAGE(A2:A21)-G2*AVERAGE(B2:B21)=15.116408
Applied Econometrics
Excel Calculations (the easy way!)
Step 1: Go to menu Tools/Data Analysis and choose
regression.
Step 2: Specify the Input Range, Output Range, and given a
choice of including or not labels in the first row.
Step 3: Input Range are columns that contain data for Y and X
(i.e. we enter $A$1:$B$21 or simply select this area using the
mouse).
Step 4: The Output Range can be either a different sheet (not
recommended) or empty cell in the current sheet (i.e. specify cell
F5).
Step 5: Since we have chosen the labels in our selection we tick
the box.
Step 6: Click <OK> to obtain the display shown in Table 4.5.
Applied Econometrics
Excel Results
Applied Econometrics: A Modern
Approach using Eviews and
Microfit Dr D Asteriou
14
Applied Econometrics
The Regression Line
Applied Econometrics
Assumptions of Ordinary Least Squares (OLS)
Linearity: Parameters must be linear. The variable can be
calculated as a linear function of a specific set of independent
variables plus a disturbance term.
Xt has some Variation: There must be variation in the values of
all independent variables.
Xt is non-stochastic (non-random) and fixed in repeated
samples: X values must be fixed in repeated sampling.
The expected (mean) value of the disturbance term is zero: The
mean of the error term must be equal to zero.
Homoskedasticity: All disturbance/error terms have the same
variance
Serial Independence: There will be no autocorrelation or the
current values of error term should be independent of its previous
values. It means all disturbance terms are independently distributed
are not correlated to each other.
Applied Econometrics
Assumptions of Ordinary Least Squares (OLS)
Normality of residuals: The residual must be normally distributed
with mean zero and common variance.
n>2 and multicolinearity: No of observations must be greater
than number of parameters estimated (n>k). Number of observation
must be greater than two or must be greater than the number of
independent variables.
Applied Econometrics
The Coefficient of Determination
18
The proportion of variability of the dependent
variable accounted for or explained by the
independent variable in a regression model.

Called R
2
and takes values from 01.
Applied Econometrics
Hypothesis Tests for Slope
of Regression Model
H
H
0
1
1
1
0
0
:
:
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=
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H
H
0
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s
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H
H
0
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( )
t
where
SS
SSE
n
SS
n
df n
b
S
S
S
S
X
X
b
b
e
XX
e
XX
=

=
=

=

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1
1
2
2
1
2
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:
the hypothesized slope
Applied Econometrics
Regression in EViews (1) (1)
Step 1 Open EViews.

Step 2 Choose File/New/Workfile to create a new file.

Step 3 Choose Undated or Irregular and specify
number of observations (in this case 20). A new
window appears which automatically contains a
constant (c) and a residual (resid) series.
Applied Econometrics
Regression in EViews (2)
Step 4 In the command line type:
genr x=0 (press enter)
genr y=0 (press enter)
which creates two new series named x and y that contain
zeros for every observation.
Open x and y as a group by selecting them and double
clicking with the mouse.

Step 5 Either type the data in EViews or copy/paste the
data from Excel. To edit the series press the edit +/
button. After editing the series press the edit +/ button
again to lock or secure the data.