Lecture1

# Lecture1 - File: C:\WINWORD\ECONMET\Lecture1.DOC UNIVERSITY...

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UNIVERSITY OF STRATHCLYDE APPLIED ECONOMETRICS LECTURE NOTES ECONOMETRIC MODELLING: THE HENDRY APPROACH, AND THE 'GENERAL TO SPECIFIC' PROCEDURE. (A) SETTING THE SCENE: THE PROBLEM ECONOMIC THEORY Suppose that economic theory suggests that an equilibrium relationship Y = X β β 1 2 + (0) exists between the two variables Y and X. OUR OBJECTIVES To establish whether the hypothesised economic relationship is supported by empirical evidence. If such support is found: To obtain 'good' estimates of the unknown parameters β 1 and β 2 (and possibly of some other parameters which will be defined shortly). To be able to test hypotheses about the unknown parameters or to construct confidence intervals surrounding our estimates. To use our estimated regression model for other purposes, including particularly 1. forecasting 2. policy analysis/simulation modelling. [B] SINGLE EQUATION ECONOMETRIC MODELLING AND THE REQUIREMENTS OF A GOOD ECONOMETRIC MODEL In these notes, we are principally concerned with the econometric analysis of economic time series - observations on each element of a set of variables over a succession of time periods. Many of the key issues and results relating to the analysis of cross-sectional series are the same as those we cover here. But in this course we do not attempt to deal with some of the specific problems arising in cross-sectional analysis. Our objective should be to construct, estimate and carry out testing in the context of a 'good' econometric model. What are the fundamental requirements of an 'adequate' econometric model? The requirements given by David Hendry, one of the leading authorities in this area, are presented in the following list. We may regard the list as forming an agenda of concepts to be explored (and applied) as this course proceeds. (1) THE MODEL MUST BE DATA ADMISSIBLE . It must be logically possible for the data to have been generated by the model that is being assumed to generate the data. This implies that the model should impose any constraints that the data are required to satisfy (e.g. they must lie within the 0-1 interval in a model explaining proportions ). (2) THE MODEL MUST BE CONSISTENT WITH SOME ECONOMIC THEORY . (3) REGRESSORS SHOULD BE (AT LEAST) WEAKLY EXOGENOUS WITH RESPECT TO THE PARAMETERS OF INTEREST. This is a requirement for valid conditioning in a single equation modelling context, to permit efficient inference on a set of parameters of interest. (4) THE MODEL SHOULD EXHIBIT PARAMETER CONSTANCY . This is essential if parameter estimates are to be meaningful, and if forecasting or policy analysis is to be valid. (5) THE MODEL SHOULD BE DATA COHERENT . The residuals should be unpredictable from their past history. This implies the need for

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## This note was uploaded on 03/01/2012 for the course EC 408 taught by Professor Rogerperman during the Fall '07 term at Uni. Strathclyde.

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Lecture1 - File: C:\WINWORD\ECONMET\Lecture1.DOC UNIVERSITY...

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