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Econometrics (1st Year of PhD)

Econometrics (1st Year of PhD)

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first year course outline
first year course outline

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Lecture Notes for Econometrics 2002 (first yearPhD course in Stockholm)
Paul Söderlind
1
June 2002 (some typos corrected and some material added later)
1
University of St. Gallen.
Address:
s/bf-HSG, Rosenbergstrasse 52, CH-9000 St. Gallen,Switzerland.
E-mail:
Paul.Soderlind@unisg.ch. Document name: EcmAll.TeX.
Contents
1 Introduction 5
1.1 Means and Standard Deviation . . . . . . . . . . . . . . . . . . . . . 51.2 Testing Sample Means . . . . . . . . . . . . . . . . . . . . . . . . . 61.3 Covariance and Correlation . . . . . . . . . . . . . . . . . . . . . . . 81.4 Least Squares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101.5 Maximum Likelihood . . . . . . . . . . . . . . . . . . . . . . . . . . 111.6 The Distribution of 
O
ˇ
. . . . . . . . . . . . . . . . . . . . . . . . . . 121.7 Diagnostic Tests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141.8 Testing Hypotheses about
O
ˇ
. . . . . . . . . . . . . . . . . . . . . . 14
A Practical Matters 16B A CLT in Action 172 Univariate Time Series Analysis 21
2.1 Theoretical Background to Time Series Processes . . . . . . . . . . . 212.2 Estimation of Autocovariances . . . . . . . . . . . . . . . . . . . . . 222.3 White Noise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252.4 Moving Average . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252.5 Autoregression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282.6 ARMA Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 352.7 Non-stationary Processes . . . . . . . . . . . . . . . . . . . . . . . . 36
3 The Distribution of a Sample Average 44
3.1 Variance of a Sample Average . . . . . . . . . . . . . . . . . . . . . 443.2 The Newey-West Estimator . . . . . . . . . . . . . . . . . . . . . . . 481
 
3.3 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
4 Least Squares 52
4.1 Definition of the LS Estimator . . . . . . . . . . . . . . . . . . . . . 524.2 LS and
R
2
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 544.3 Finite Sample Properties of LS . . . . . . . . . . . . . . . . . . . . . 564.4 Consistency of LS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 574.5 Asymptotic Normality of LS . . . . . . . . . . . . . . . . . . . . . . 594.6 Inference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 624.7 Diagnostic Tests of Autocorrelation, Heteroskedasticity, and Normality
65
5 Instrumental Variable Method 73
5.1 Consistency of Least Squares or Not? . . . . . . . . . . . . . . . . . 735.2 Reason 1 for IV: Measurement Errors . . . . . . . . . . . . . . . . . 735.3 Reason 2 for IV: Simultaneous Equations Bias (and Inconsistency) . . 755.4 Definition of the IV Estimator—Consistency of IV . . . . . . . . . . 795.5 Hausman’s Specification Test
. . . . . . . . . . . . . . . . . . . . . 855.6 Tests of Overidentifying Restrictions in 2SLS
. . . . . . . . . . . . 86
6 Simulating the Finite Sample Properties 88
6.1 Monte Carlo Simulations in the Simplest Case . . . . . . . . . . . . . 886.2 Monte Carlo Simulations in More Complicated Cases
. . . . . . . . 906.3 Bootstrapping in the Simplest Case . . . . . . . . . . . . . . . . . . . 926.4 Bootstrapping in More Complicated Cases
. . . . . . . . . . . . . . 92
7 GMM 96
7.1 Method of Moments . . . . . . . . . . . . . . . . . . . . . . . . . . 967.2 Generalized Method of Moments . . . . . . . . . . . . . . . . . . . . 977.3 Moment Conditions in GMM . . . . . . . . . . . . . . . . . . . . . . 977.4 The Optimization Problem in GMM . . . . . . . . . . . . . . . . . . 1007.5 Asymptotic Properties of GMM . . . . . . . . . . . . . . . . . . . . 1047.6 Summary of GMM . . . . . . . . . . . . . . . . . . . . . . . . . . . 1097.7 Efficient GMM and Its Feasible Implementation . . . . . . . . . . . . 1107.8 Testing in GMM . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11127.9 GMM with Sub-Optimal Weighting Matrix
. . . . . . . . . . . . . . 1137.10 GMM without a Loss Function
. . . . . . . . . . . . . . . . . . . . 1147.11 Simulated Moments Estimator
. . . . . . . . . . . . . . . . . . . . . 115
8 Examples and Applications of GMM 118
8.1 GMM and Classical Econometrics: Examples . . . . . . . . . . . . . 1188.2 Identification of Systems of Simultaneous Equations . . . . . . . . . 1248.3 Testing for Autocorrelation . . . . . . . . . . . . . . . . . . . . . . . 1278.4 Estimating and Testing a Normal Distribution . . . . . . . . . . . . . 1318.5 Testing the Implications of an RBC Model . . . . . . . . . . . . . . . 1358.6 IV on a System of Equations
. . . . . . . . . . . . . . . . . . . . . 136
11 Vector Autoregression (VAR) 138
11.1 Canonical Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13811.2 Moving Average Form and Stability . . . . . . . . . . . . . . . . . . 13911.3 Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14111.4 Granger Causality . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14211.5 Forecasts Forecast Error Variance . . . . . . . . . . . . . . . . . . . 14311.6 Forecast Error Variance Decompositions
. . . . . . . . . . . . . . . 14411.7 Structural VARs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14511.8 Cointegration and Identification via Long-Run Restrictions
. . . . . 155
12 Kalman lter 162
12.1 Conditional Expectations in a Multivariate Normal Distribution . . . . 16212.2 Kalman Recursions . . . . . . . . . . . . . . . . . . . . . . . . . . . 163
13 Outliers and Robust Estimators 169
13.1 Influential Observations and Standardized Residuals . . . . . . . . . . 16913.2 Recursive Residuals
. . . . . . . . . . . . . . . . . . . . . . . . . . 17013.3 Robust Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17213.4 Multicollinearity
. . . . . . . . . . . . . . . . . . . . . . . . . . . . 173
14 Generalized Least Squares 175
14.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17514.2 GLS as Maximum Likelihood . . . . . . . . . . . . . . . . . . . . . 1763
 
14.3 GLS as a Transformed LS . . . . . . . . . . . . . . . . . . . . . . . 17914.4 Feasible GLS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179
15 Nonparametric Regressions and Tests 181
15.1 Nonparametric Regressions . . . . . . . . . . . . . . . . . . . . . . . 18115.2 Estimating and Testing Distributions . . . . . . . . . . . . . . . . . . 189
21 Some Statistics 196
21.1 Distributions and Moment Generating Functions . . . . . . . . . . . . 19621.2 Joint and Conditional Distributions and Moments . . . . . . . . . . . 19721.3 Convergence in Probability, Mean Square, and Distribution . . . . . . 20121.4 Laws of Large Numbers and Central Limit Theorems . . . . . . . . . 20321.5 Stationarity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20321.6 Martingales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20321.7 Special Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . 20521.8 Inference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214
22 Some Facts about Matrices 216
22.1 Rank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21622.2 Vector Norms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21622.3 Systems of Linear Equations and Matrix Inverses . . . . . . . . . . . 21622.4 Complex matrices . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21922.5 Eigenvalues and Eigenvectors . . . . . . . . . . . . . . . . . . . . . . 21922.6 Special Forms of Matrices . . . . . . . . . . . . . . . . . . . . . . . 22022.7 Matrix Decompositions . . . . . . . . . . . . . . . . . . . . . . . . . 22222.8 Matrix Calculus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22722.9 Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2304
1 Introduction
1.1 Means and Standard Deviation
The mean and variance of a series are estimated as
N
x
D
P
t
D
1
x
t
=T 
and
O
 
2
D
P
t
D
1
.x
t
 N
x/
2
=T:
(1.1)The standard deviation (here denoted Std
.x
t
/
), the square root of the variance, is the mostcommon measure of volatility.The mean and standard deviation are often estimated on rolling data windows (for in-stance, a “Bollinger band” is
˙
2
standard deviations from a moving data window arounda moving average—sometimes used in analysis of financial prices.)If 
x
t
is iid (independently and identically distributed), then it is straightforward to findthe variance of the sample average. Then, note thatVar
P
t
D
1
x
t
=T 
Á
D
P
t
D
1
Var
.x
t
=T/
D
Var
.x
t
/=T 
2
D
Var
.x
t
/=T:
(1.2)Thefirstequalityfollows fromthe assumptionthat
x
t
and
x
s
areindependentlydistributed(so the covariance is zero). The second equality follows from the assumption that
x
t
and
x
s
are identically distributed (so their variances are the same). The third equality is atrivial simplification.A sample average is (typically) unbiased, that is, the expected value of the sampleaverage equals the population mean. To illustrate that, consider the expected value of thesample average of the iid
x
t
E
P
t
D
1
x
t
=T 
D
P
t
D
1
E
x
t
=T 
D
E
x
t
:
(1.3)The first equality is always true (the expectation of a sum is the sum of expectations), and5

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