321w11p1 - Multicollinearity Perfect Multicollinearity one...

Info iconThis preview shows pages 1–6. Sign up to view the full content.

View Full Document Right Arrow Icon
Multicollinearity Perfect Multicollinearity – one regressor is a perfect linear combination of one or more of the other regressors. perfect multicollinearity: x j = 1 x 1  2 x 2 ...  k x k , where i 0for at least one i. It is easy to solve the problem of perfect multicollinearity by dropping or combining one or more of the independent variables.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
However, with Imperfect Multicollinearity, we face a different dillemna. Imperfect Multicollinearity – two or more regressors are highly correlated. There are no theoretical issues with OLS estimators in the case of imperfect multicollinearity.
Background image of page 2
But if there is a very high correlation between two variables, at least one coefficient will be imprecisely estimated. Recall: Var j = 2 SST j 1 R j 2 The higher the correlation among the regressors, the higher is R j , the smaller the denominator and the higher the variance of j . So when you include highly correlated variables, you are likely to see imprecise estimates for at least one regressor.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
How much correlation is too much? Addressing Multicollinearity: 1. Use joint hypothesis tests instead of individual t-ratios 2. Factor Analysis 3. Drop one or more variables
Background image of page 4
Ex/ Suppose we wish to estimate the effect of University quality on wages and estimate the following regression for Canadian students:
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 6
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 01/26/2012 for the course ECON 401 taught by Professor Burbidge,john during the Fall '08 term at Waterloo.

Page1 / 20

321w11p1 - Multicollinearity Perfect Multicollinearity one...

This preview shows document pages 1 - 6. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online