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4_multicollinearity

# 4_multicollinearity - Research Methods in Economics ECO...

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1 Research Methods in Economics ECO 4451 2 Introduction y There might be consequences to adding variables to a model “Multicollinearity” is high correlation involving two or more IVs y 1. One IV influences another IV y 2. Two or more IVs influence (or influenced by) a third IV Slide # 3 Multicollinearity y Consequences y 1. Can drastically alter results from one model to another y 2. Can cause problems in interpreting results Slide # 4 Do Market Size and Wins Affect NBA Teams’ Profits? Profit Market Size Wins 33.4 3 57 22.0 3 63 16.0 3 46 8.7 2 42 5.4 2 44 4.7 2 55 1 5 1 35 Slide # 5 See regression output for multicollinearity. -1.5 -2.1 1 13 -4.0 1 28 NOTE: NBA market size = 3 for large, 2 for medium, 1 for small NOTE: Don't use this approach for measuring market size. Use a better measure like population. Profit is in millions of \$. Example Where PROFIT i l fi ( M) PROFIT = β 0 + β 1 MKTSIZE + β 2 WINS+ μ y PROFIT is annual team profit (\$1M) y MKTSIZE = 3 for large, 2 for medium, 1 for small y WINS is no. of wins in one season Slide # 6

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2 Variables A B C Constant 17.16 16.74 17.06 (0.009) (0.10) (0.03) MKTSIZE 13.17 13.28 ( 6) ( ) Example (cont.) (0.0006) (0.02) WINS 0.61 .008 (0.02) (0.98 ) Slide # 7 (p-values in parentheses) Variables A B C Constant 17.16 16.74 17.06 (0.009) (0.10) (0.03) MKTSIZE 13.17 13.28 ( 6) ( ) Examine t-stat p-values Models A & B vs. model C (0.0006) (0.02) WINS 0.61 .008 (0.02) (0.98 ) Slide # 8 (p-values in parentheses) Variables A B C Constant 17.16 16.74 17.06 (0.009) (0.10) (0.03) MKTSIZE 13.17 13.28 Examine coefficient values Models A & B vs. model C (0.0006) (0.02) WINS 0.61 .008 (0.02) (0.98 ) Slide # 9 (p-values in parentheses) Example (cont.) y Point y 1. Observed changes across models due to high correlation/multicollinearity between WINS & MKTSIZE y correlation = 0.835 Slide # 10 Note y 1. High correlation among IVs BAD y 2. High correlation between IV, DV GOOD Slide # 11 Exact Multicollinearity y A. Definition y 1. Two or more IVs perfectly (or nearly perfectly) correlated y 2 What would be values of correlation coefficients? 2. What would be values of correlation coefficients? Slide # 12