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midterm2_2009 - 73-261 Econometrics November 4 2009 Midterm...

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73-261 Econometrics November 4, 2009 Midterm 2 50 minutes. 50 points. Write answers in the Blue Book. Do not forget to write your name on it. 1. [8 points] The following regression has been run in an attempt to explain savings decisions of people in various socioeconomic groups: savings = β 0 + β 1 income + β 2 married + β 3 income*married + u Dataset also included series black , female and ParentEduc . The distribution of variables in the dataset is representative of the general US population. What is a potential issue with this regression? How would it affect the estimates? How would you fix that issue? How would you check whether the issue is present? 2. [5 points] A friend of yours is trying to predict daily stock price movements from previous- day movements. Stock price s t is a positive real number, and s t +1 = s t +1 s t . Your friend wants to find the best predictor, and plans to run the following regression: s t +1 = β 0 + β 1 s t + β 2 ( s t / s t 1 ) + β 3 [log( s t ) log( s t 1 )] + β 4 log( s t / s t 1 ) + u Can you anticipate a problem with this regression? What is it? How can it be avoided? 3. [7 points] You have run a regression over 10,000 observations, and the histogram of the fitted residuals ( i U ˆ 's) looks more like Uniform distribution rather than Normal. Your teammate
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