3 views

Uploaded by connythecon

Bayes Probability

save

You are on page 1of 8

Leandro Magnusson

∗†

Department of Economics

Brown University

Leandro Magnusson@brown.edu

http://www.econ.brown.edu/students/Leandro Magnusson/

April 26, 2006

Preliminary Version

Abstract

This material is used as a reference for the computer exercises of the Bayesian econometrics course

taught by Professor Tony Lancaster. It covers a variety of models (linear regression models, limited

depended variable models (logit, probit and Tobit), etc). The Bayesian computation is done in BUGS

using R as its interface. Both softwares can be download freely from their respective web pages:

http://www.mrc-bsu.cam.ac.uk/bugs/ and

http://www.r-project.org/.

∗

w

†

q

1

1 First Order Auto Regressive Model

Model: The AR(1) and ARMA(1,1) model are:

y

t

= ρy

t−1

+ε

t

, ε

t

∼ N(0, τ) (1.1)

y

t

= ρy

t−1

+ε

t

, ε

t

= u

t

−θu

t−1

, {u

t

}

T

t=0

is i.i.d., u

t

∼ N(0, σ) (1.2)

where −1 < ρ < 1 . The Durbin-Watson statistic of the AR(1) errors is:

dw =

T

t=2

(ε

t

−ε

t−1

)

T

t=2

(ε

2

t−1

)

ε

t

= y

t

−ρy

t−1

(1.3)

Exercise 1. (Based on Example 2.15, page 95, Lancaster (2004))

In R, generate a sequence of AR(1) and a sequence of ARMA(1,1) observations with the same initial

value. Let’s assume the both sample are AR(1), the prior distribution of ρ is improper and τ is known.

(a) What is the likelihood for the AR(1) model (p(y|ρ))?

(b) Generate ρ from its posterior distribution (ρ ∼ N(ˆ ρ,

T

t=1

y

2

t−1

)).

(c) Generate a sequence of y

rep

from its predictive distribution and compute

diff(ρ, y

rep

, y

obs

) = dw(ρ, y

rep

) −dw(ρ, y

obs

)

(d) Repeat items (b), (c) n times separately for AR(1) and ARMA(1,1).

(e) Plot the distributions of df(ρ, y

rep

, y

obs

) and draw your conclusions.

2 Linear Regression Models

2.1 Independent, normal, homoscedastic errors

Database: See Mankiw et al. (1992).

Model: Solow Model

without human capital: Y

t

= K

α

t

(A

t

L

t

)

1−α

with human capital: Y

t

= K

α

t

H

β

t

(A

t

L

t

)

1−α−β

where L

t

= L

0

exp(nt) and A

t

= A

0

exp(gt). Consider that A

0

= a + , where a is constant and is a

country-speciﬁc shock. The basic empirical speciﬁcations for the Solow model are:

ln

_

Y

L

_

= a +

α

1 −α

ln(s

k

) −

α

1 −α

ln(n +g +δ) + (2.1)

ln

_

Y

L

_

= a +

α

1 −α −β

ln(s

k

) +

β

1 −α −β

ln(s

h

) −

α +β

1 −α −β

ln(n +g +δ) + (2.2)

where s

k

is the capital savings rate, s

h

is the human capital savings rate, n is the population growth rate, g

is technical growth rate, δ depreciation. Mankiw et al. (1992) assume that g +δ = 0.05.

2

Exercise 2.

(a) Consider the following unrestricted speciﬁcation

ln

_

Y

L

_

= a +b

1

ln(s

k

) +b

2

ln(n +g +δ) +

What is the likelihood for the above model? How would you choose the priors?

(b) Write and run a BUGS program for the linear regression model. Do separately for nonoil, intermediate

and oecd countries. Compare your answers with the maximum likelihood estimates.

(c) Propose and run a test for the coeﬃcients b

1

and b

2

for each group of countries. How could you test the

hypothesis about the returns to scale?

(d) Include human capital and repeat parts (a), (b) and (c).

2.2 Heteroscedasticy

Database: See Yatchew & No (2001)

Model: Consider the log linear form of the demand of gasoline:

log(gas) = β

0

+β

1

log(price) +β

2

log(income) +u (2.3)

In matrix notation, the OLS terms are: v = N − k (the degrees of freedom),

ˆ

β = (X

X)

−1

X

y and

s

2

=

(y−X

ˆ

β)

(y−X

ˆ

β)

v

. Assuming normality and homoscedasticity of the residuals, the likelihood function is:

1

p(y|β, τ) =

1

(2π)

N

2

_

τ

1

2

exp

_

−

τ

2

(β −

ˆ

β)X

X(β −

ˆ

β)

___

τ

v

2

exp

_

−

τv

2s

−2

__

If the residuals have the same variance we have:

E

_

u

2

−σ

2

¸

2

= 2σ

4

where σ

2

is the variance (σ

2

=

1

τ

). Therefore a simple statistic to verify if the residuals have equal variance

is:

T(β, σ

2

) =

N

i=1

((y

i

−x

i

β)

2

−σ

2

)

N

− 2σ

4

Student linear model Take a look at Lancaster (2004), chapter 3, pages 159-162. Assume that:

u

i

|X, β, τ, λ

i

∼ N(0, τλ

i

)

where {λ

i

}

N

i=1

is independently gamma distributed with mean 1 and scalar hyperparameter d. Multiplying

the density of u

i

|X, β, τ, λ

i

by the density of {λ

i

}

N

i=1

and integrating out λ’s one may show that u

i

|X, β, τ

follows a t- distribution with mean 0 and degrees of freedom equals to d.

1

For a formal derivation see Koop (2003)

3

Exercise 3.

(a) Assuming that the errors have the same variance, suggest a natural conjugate prior for this model

and derive the posterior distribution of β and τ. Write a program in R for sampling of the posterior

distribution of β and τ.

(b) Simulate β and σ

2

from the joint distribution and evaluate T(β, σ

2

). Repeat nrep times and the draw

the histogram of the test statistic. What are you conclusions?

(c) Write down a BUGS program for the student linear model. Explore how the posterior inferences about

β change by using diﬀerent values of d. Remember that low values of d approximates the t-distribution

to a Cauchy (have tails) and large values of d approximates to a normal distribution.

3 Limited Dependent Variable Models

3.1 Logit

Database: See Slonim & Roth (1998).

Deﬁnition: (Ultimatum Game)

The ultimatum game consists of two players bargaining over the amount of money which it will be

called “pie”. One player, the proposer, proposes a division of the pie, and the second player, the

responder, accepts or rejects it. If the responder accepts , each player earns the amount speciﬁed

in the proposal and if the responder rejects, each player earns zero. At perfect equilibrium the

proposer receives all or almost all of the pie.

Model: Rejection behavior

Prob(R = 1) = Λ(a +b

0

∗ Of +b

M

∗ pM +b

H

∗ pH) (3.1)

where Λ is the logistic distribution function, R equals 1 if the oﬀer is reject and 0 otherwise, Of is the

proportion of the pie oﬀered (from 0 to 49,5%), pM = 1 if stakes are medium and pH = 1 is stakes are high.

Exercise 4.

(a) What is the likelihood for the above model? How would you choose the prior?

(b) Write and run a BUGS program for the logit model. Study the convergence of the sampler (try 3000 inter-

actions burning 1000 and 10000 interactions burning 8000). Compare your answers with the maximum

likelihood estimates.

(c) Evaluate the rejection probability at various oﬀer values:

of =

_

0.1 0.2 0.3 0.4 0.5

_

;

do this separately for the low, medium, and high stakes conditions.

(d) Does the level of the stakes aﬀect the rejection probability. Propose a test and compute it. What is your

conclusion?

4

3.2 Tobit

Database: See Mroz (1987)

Model: (Labor supply of Married Women) The reduced form of a woman’s labor supply is given by:

2

h

i

= a

0

+a

1

Y

i

+a

2

Z

i

+u

i

where h

i

is the ith woman’s hour of work during a given year, Y

i

is a measure of other income received by

the household, Z

i

is a set of control variables which includes her age, the number of children less than six

years old, the number of children between ages of ﬁve and nineteen her years of schooling, her experience in

years and the square of experience; and u

i

is a stochastic term which is assumed to be normally distributed.

Deﬁne the labor force participation as d

i

= 1 if h

1

> 0 and d

i

= 0 otherwise.

The Tobit likelihood is given by:

p(h|a

s, τ) =

N

i=1

_

Φ

_

τ

.5

(a

0

+a

1

Y

i

+a

2

Z

i

)

_

1−d

i

×

τ

.5

φ

_

τ

.5

(h

i

− (a

0

+a

1

Y

i

+a

2

Z

i

))

_

d

i

_

(3.2)

where Φ and φ are the normal distribution and density functions, respectively.

Sampling with data augmentation: Suppose we could observe h

∗

the potential hours of work for

every married woman which may also be negative. Thence p(a

s, τ|h

∗

) = p(a

s, τ|h

∗

, h) is the posterior for

a

**s and τ derived from the linear normal likelihood model. We do not observe h
**

∗

but its conditional density

p(h

∗

|h = 0, a

**s, τ) is normally left truncated. Therefore we have the following Gibbs Sampler Algorithm
**

with the parameter set augmented by h

∗

for censored observations:

1) Choose a initial value for h

∗

, a’s and τ;

2) Sample a

s and τ from p(a

s, τ|h

∗

);

3) Sample h

∗

from the truncated normal p(h

∗

|h = 0, a

s, τ);

4) Repeat 2 and 3 nrep times.

Exercise 5.

(a) Write a BUGS program for the Tobit model.

(b) Write a R program using data augmentation. (In the library msm provides the function tnorm(µ,σ

2

))

truncated normal

2

The woman’s wage rate, the endogenous explanatory variable, is assumed to be a linear function of Y

i

and Z

i

.

5

4 Instrumental Variable Model

4.1 Recursive Equation Model

Database: See Romer (1993)

Model: In a closed economy, the Lucas model for the relationship between output and inﬂation is:

y = y

∗

+β(π −π

e

) (4.1)

where y is actual output, y

∗

the natural rate, π inﬂation, and π

e

expected inﬂation, and where β > 0.

Unanticipated monetary shocks aﬀect both prices and real output. The policy-maker’s objective (welfare)

function is:

W = −

1

2

π

2

+γy (4.2)

where γ > 0. The policy-maker chooses inﬂation π. Assuming rational expectations, i.e. private agents

known optimization problem of the policy maker, the equilibrium is π = π

e

= γβ and y = y

∗

: inﬂation is

positive and output is at natural rate (suboptimal equilibrium).

Openness aﬀects the output-inﬂation trade-oﬀ (increased openness raises de amount of inﬂation associated

with a given expansion of domestic output; that is, it reduces β) and the beneﬁt of higher output relative to

the cost of higher inﬂation (γ is decreasing in the degree of openness).

Romer (1993) considers the following linear relation between inﬂation and output:

log π = b

0

+b

1

∗

I

Y

+b

2

∗ log y +b3 ∗ dd +b4 ∗ rd (4.3)

where log π is the log of the average inﬂation 73-93,

I

Y

is the average share of imports in GDP or GNP, log y

is the log of real income per capita, dd are dummies for alternative measures of openness and inﬂation and

rd are regional dummies. A priori we expect that b

1

< 0. According to the author,

I

Y

is endogenous since

the adoption of protectionism policies that beneﬁt some interest groups leads to larger budget deﬁcits and

therefore inﬂation. As instrument he uses land area (in logarithms).

Exercise 6.

(a) How would you translate the instrumental variable model into a recursive system model? Deﬁne the

likelihood and the priors for the recursive system.

(b) Write a Bugs program for the recursive model. Could you propose an exogeneity test for openness?

4.2 Multinomial Approach (Bayesian Bootstrap)

Database: See Romer (1993)

Model: Another approach for the previous model is to consider only moment conditions. Under mean

independence we have:

E[Z

(y −Xβ)] = 0

6

The likelihood is derived from the multinomial distribution and its natural conjugate prior is the dirichlet

distribution. For more details, take a look at Lancaster (2004) chapter 3, section 3.4, pages 141-147.

Exercise 7.

(a) Sample β from its posterior and compare to the posterior distribution of the previous exercise. (Remember

that you can sample β from

β = [Z

GX]

−1

Z

Gy

where G is a diagonal matrix whose components are i.i.d exponentially distributed)

(b) How would you propose and exogeneity test in this context?

7

References

Koop, G. (2003), Bayesian Econometrics, ﬁrst edn, Wiley.

Lancaster, T. (2004), An Introduction to Modern Bayesian Econometrics, ﬁrst edn, Blackwell Publishing.

Mankiw, N. G., Romer, D. & Weil, D. N. (1992), ‘A contribution to the empirics of economic growth’,

Quartely Journal of Economics 107(2), 407–437.

Mroz, T. A. (1987), ‘The sensitivity of an empirical model of married women’s hours of work to economic

and statistical assumptions’, Econometrica 55(4), 765–799.

Romer, D. (1993), ‘Openness and inﬂation: Theory and evidence’, Quartely Journal of Economics

108(4), 869–903.

Slonim, R. & Roth, A. E. (1998), ‘Learning in high stakes ultimum games: an experiment in the slovak

republic’, Econometrica 66(3), 569–596.

Yatchew, A. & No, J. (2001), ‘Household gasoline demand in canada’, Econometrica 69(6), 1697–1709.

8

- MSQ171_SG_T07Uploaded byUsman Elahi
- Comparing the Performance of Public and PrivateUploaded bynobitaenoki
- Problem Set 2 SolutionUploaded bypntgaur54185
- Module Descriptor - Statistics for Management (MSTC2202)Uploaded byDebapriya Paul Chakrabarti
- 1508302587Uploaded byDaryAnto
- Demystifying Gaussian Distribution (2)Uploaded byDebashis Ghosh
- Segunda Asignación de Estadística Aplicada a La IngenieríaUploaded byBrian Williams
- Residual AnalysisUploaded byGagandeep Singh
- lecture_1-20-15Uploaded byscmret
- Probability:Basic ideasUploaded byMeshkatus Salehin
- chapter6-exerciesextraUploaded byHassan Mosa
- Akhtaruddin, 2005, Corporate Mandatory Disclosure Practices in BangladeshUploaded bySwapon Ahmed
- Least Squares EstimationUploaded byKofi Deh
- Matlab ExamplesUploaded byAnnaChithySalu
- Locality Preserving PropertyUploaded bynanjilba
- 7 bivariate edaUploaded byAman Sodi
- NIG_EGWUploaded byZuzana Macova
- Pay and EquityUploaded byJoujou Trabelsi
- 041254380 x Capability IndicesUploaded bystudentul86
- Lecture02 Random VariablesUploaded byMuhammad Inam Ur Rehman

- Estimation Error and Port OptimizationUploaded byconnythecon
- Calculating U.S. Treasury Futures Conversion Factors Final Dec 4[1]Uploaded byconnythecon
- IV Using Variance DecompositionUploaded byconnythecon
- bsmUploaded bybjj_99
- Delta Surface Methodology - Implied Volatility Surface by DeltaUploaded byShirley Xin
- Grant's Interest Rate Observer Winter Break EditionUploaded byevolve_us
- An Introduction to the Kalman Filter (FULL VERSION)Uploaded bykasra_tm
- LIBOR as a risky rateUploaded byconnythecon
- Traders Magazine Dec 2011Uploaded byconnythecon
- Fow-Investing in VolatilityUploaded byRahul Sood

- ijest-ng-vol3-no8-pp1-12Uploaded byAnonymous iSsmdc
- CSA O86-14 Commentary.pdfUploaded byGanja Man
- erf(t)Uploaded bybrayan2904
- Getting Started With RUploaded byRishabh Gautam
- Probabilidade12Uploaded byiamendes
- ICDAS Criteria Document Corrected 2013Uploaded byAvita Rath
- ESTATISTICA APOSTILAUploaded byLevi Vieira
- RegressionUploaded byHardik Sharma
- Alfa de CronbachUploaded byAlejandro Bravo
- Sesion 01 Estadistica -Tema Estadistica Descriptiva Parte IIUploaded byedidson fuentes
- Article ThesisUploaded byRussell Abrantes
- Uncertainty NotesUploaded byDipesh Basnet
- 85857385-SQC-Chapter-6-11Uploaded byqwert 12345
- La Distribución Normal.pdfUploaded byfelipe_cruzp
- OutputUploaded byKanupriya Choudhary
- Regresión-Múltiple 2Uploaded byCarlos David Macias Marulanda
- Proba Intermedia Basica 1Uploaded byGerardo Sixtos
- Executive Summary: Police Incident Analysis at Penn State Football GamesUploaded byJuan Devia
- Medidas de Tendencia CentralUploaded bySandra Cristina Fernandes
- Theoretical Analysis ReportUploaded bywtt1640
- Analisis multinivelUploaded by290971
- ProgDescriptiva.pdfUploaded byAldrin Hernandez
- Probabilidad y EstadísticaUploaded byLorena Rodríguez
- Rol e AmplitudeUploaded byTIAGO
- envejecimiento de arcillas, y la mejora de la plasticidadUploaded byBell Chavez Cruz
- Temperature lapse rate studyUploaded byminotshing maza
- Classification and Regression Trees - Olshen R AUploaded byBenjamin Koh
- Medidas de SimetríaUploaded byEliaz Hernandez
- Apuntes Estadística Inferencial Juárez y VillatoroUploaded byMorelosAaron
- hep146bioapostilaUploaded byItaceni Sousa