Week2Notes - 1 ECON3300/7360 APPLIED ECONOMETRICS Week 2...

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1 ECON3300/7360 A PPLIED E CONOMETRICS Week 2 Lecture Outline 1. Diagnostic Tests and Problem Solving – Hill and Gujarati Texts
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2 Diagnostic Tests and Problem Solving Misspecification of functional form Y = f (K, L) GDP = α 0 + α 1 K + α 2 L Unsatisfactory Ramsey Reset test statistic - what can be done? Multicollinearity 4 43 4 42 1 4 4 4 4 1 1 Pr 4 3 2 Pr 2 1 0 / oblem oblem I r i L K GDP α + + + + = What can be done?
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3 Detecting multicollinearity (1) Check correlation coeff between independent variables (2) Large std. errors for estimators t-tests would lead to conclusion of insignificance (3) Estimates may be sensitive to addition or removal of a few observations or variables Heteroscedasticity - non-constant variance, that is, Var( ε i ) = σ 2 i - with incorrect or varying standard errors, confidence intervals and hypothesis tests are invalid. ( see Fig. 11.1 and 11.2) Eg. Y = β 1 + β 2 X+ ε where Y = household expenditure on food X = household income
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4 x x x x x x x x x ˆ ˆ y ˆ 2 1 β + β = Y X (income) Other Causes of Hetero 1. Due to omitted variables Wage t = β 0 + β 1 Gender t + β 2 Education t + U t 2. Due to non-linearity in functional form Y = β 0 + β 1 X + U X Residuals Y = β 0 + β 1 X + β 2 X 2 + V
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5 Tests for Hetero 1. Residual Plots 2 ˆ u 2 ˆ u 2 ˆ u X X X 2. Goldfeld – Quandt Test 3. Breusch – Pagen Test 4. White Test Y = β 0 + β 1 X 1 + β 2 X 2 + u 2
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Week2Notes - 1 ECON3300/7360 APPLIED ECONOMETRICS Week 2...

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