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- Homework 8
- BA H DSEC IiApplied Econometrics 5th Sem
- Standard Deviation
- 2 the Linear Regression Model
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- Statistical Inference II
- Parameter Estimation and Hypothesis Testing for the Truncated Nor.pdf
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measurement is an important part of econometrics, the scope of econometrics is much

broader, as can be seen from the following quotations:

Econometrics, the result of a certain outlook on the role of economics, consists of the

application of mathematical statistics to economic data to lend empirical support to the

models constructed by mathematical economics and to obtain numerical.

Econometrics may be defined as the quantitative analysis of actual economic

phenomena based on the concurrent development of theory and observation, related by

appropriate methods of inference.

Econometrics may be defined as the social science in which the tools of economic

theory, mathematics, and statistical inference are applied to the analysis of economic

phenomena.3

Econometrics is concerned with the empirical determination of economic laws.

Although there are several schools of thought on econometric methodology, we

present here the traditional or classical methodology, which still dominates empirical

research in economics and other social and behavioral sciences.

Econometrics is the application of mathematics, statistical methods, and computer

science, to economic data and is described as the branch of economics that aims to

give empirical content to economic relations.[1] More precisely, it is "the quantitative

analysis of actual economic phenomena based on the concurrent development of

theory and observation, related by appropriate methods of inference.

Broadly speaking, traditional econometric methodology proceeds along the following

lines:

1. Statement of theory or hypothesis.

2. Specification of the mathematical model of the theory

3. Specification of the statistical, or econometric, model

4. Obtaining the data

5. Estimation of the parameters of the econometric model

6. Hypothesis testing

7. Forecasting or prediction

8. Using the model for control or policy purposes.

Answer 2.

In regression analysis we are concerned with what is known as the statistical, not

functional or deterministic, dependence among variables, such as those of classical

physics.

In statistical relationships among variables we essentially deal with random or

stochastic4 variables, that is, variables that have probability distributions. In functional

or deterministic dependency, on the other hand, we also deal with variables, but these

variables are not random or stochastic. The dependence of crop yield on temperature,

rainfall, sunshine, and fertilizer, for example, is statistical in nature in the sense that

the explanatory variables, although certainly important, will not enable the agronomist

to predict crop yield exactly because of errors involved in measuring these variables as

well as a host of other factors (variables) that collectively affect the yield but may be

difficult to identify individually. Thus, there is bound to be some intrinsic or random

variability in the dependent-variable crop yield that cannot be fully explained no

matter how many explanatory variables we consider.

In deterministic phenomena, on the other hand, we deal with relationships of the type,

say, exhibited by Newtons law of gravity, which states: Every particle in the universe

attracts every other particle with a force directly proportional to the product of their

masses and inversely proportional to the square of the distance between them.

Symbolically, F = k(m1m2/r 2), where F = force, m1 and m2 are the masses of the two

particles, r = distance, and k = constant of proportionality. Another example is Ohms

law, which states: For metallic conductors over a limited range of temperature the

current C is proportional to the voltage V; that is, C = ( 1 k )V where 1 k is the

constant of proportionality. Other examples of such deterministic relationships are

Boyles gas law, Kirchhoffs law of electricity, and Newtons law of motion. In this

text we are not concerned with such deterministic relationships. Of course, if there are

errors of measurement, say, in the k of Newtons law of gravity, the otherwise

deterministic relationship becomes a statistical relationship. In this situation, force can

be predicted only approximately from the given value of k (and m1, m2, and r), which

contains errors. The variable F in this case becomes a random variable.

Answer 3.

Endogenous variable: A factor in a causal model or causal system whose value is

determined by the states of other variables in the system; contrasted with

an exogenous variable. Related but non-equivalent distinctions are those between

dependent and independent variables and between explanandum and explanans. A

factor can be classified as endogenous or exogenous only relative to a specification of

a model representing the causal relationships producing the outcome y among a set of

causal factors X (x1, x2, xk) (y = M(X)). A variable xj is said to be endogenous within

the causal model M if its value is determined or influenced by one or more of the

independent variables X(excluding itself). A purely endogenous variable is a factor

that is entirely determined by the states of other variables in the system. (If a factor is

purely endogenous, then in theory we could replace the occurrence of this factor with

the functional form representing the composition of xj as a function of X.) In real

causal systems, however, there can be a range of endogeneity. Some factors are

causally influenced by factors within the system but also by factors not included in the

model. So a given factor may be partially endogenous and partially exogenous

partially but not wholly determined by the values of other variables in the model.

Consider a simple causal systemfarming. The outcome we are interested in

explaining (the dependent variable or the explanandum) is crop output. Many factors

(independent variables, explanans) influence crop output: labor, farmer skill,

availability of seed varieties, availability of credit, climate, weather, soil quality and

type, irrigation, pests, temperature, pesticides and fertilizers, animal practices, and

availability of traction. These variables are all causally relevant to crop yield, in a

specifiable sense: if we alter the levels of these variables over a series of tests, the

level of crop yield will vary as well (up or down). These factors have real causal

influence on crop yield, and it is a reasonable scientific problem to attempt to assess

the nature and weight of the various factors. We can also notice, however, that there

are causal relations among some but not all of these factors. For example, the level of

pest infestation is influenced by rainfall and fertilizer (positively) and pesticide, labor,

and skill (negatively). So pest infestation is partially endogenous within this system

and partially exogenous, in that it is also influenced by factors that are external to this

system (average temperature, presence of pest vectors, decline of predators, etc.).

The concept of endogeneity is particularly relevant in the context of time series

analysis of causal processes. It is common for some factors within a causal system to

be dependent for their value in period n on the values of other factors in the causal

system in period n-1. Suppose that the level of pest infestation is independent of all

other factors within a given period, but is influenced by the level of rainfall and

fertilizer in the preceding period. In this instance it would be correct to say that

infestation is exogenous within the period, but endogenous over time.

causal system whose value is independent from the states of other variables in the

system; a factor whose value is determined by factors or variables outside the causal

system under study. For example, rainfall is exogenous to the causal system

constituting the process of farming and crop output. There are causal factors that

determine the level of rainfallso rainfall is endogenous to a weather modelbut

these factors are not themselves part of the causal model we use to explain the level of

crop output. As with endogenous variables, the status of the variable is relative to the

specification of a particular model and causal relations among the independent

variables. An exogenous variable is by definition one whose value is wholly causally

independent from other variables in the system. So the category of exogenous

variable is contrasted to those of purely endogenous and partially endogenous

variables. A variable can be made endogenous by incorporating additional factors and

causal relations into the model. There are causal and statistical interpretations of

exogeneity. The causal interpretation is primary, and defines exogeneity in terms of

the factors causal independence from the other variables included in the model. The

statistical or econometric concept emphasizes non-correlation between the exogenous

variable and the other independent variables included in the model. If xj is exogenous

to a matrix of independent variables X (excluding xj), then

QW if we perform a

regression of xj against X (excluding xj), we should expect coefficients of 0 for each

variable in X (excluding xj). Normal regression models assume that all the

independent variables are exogenous.

Answer 4

Methodology of Economic Research

It involves the following process:

1. Theoretical observation/ Hypothesis/ Law etc

Law of demand, Law of Supply etc

2. Identification of dependant (regrassand ) and in dependant (explanatory and

regressors) variables.

In law of demand regressand is Qd( quantity Demanded) and regressors are P (own

price), Pr(Price of related goods), Y(Consumers Income) and T (tastes and prefereces).

Thus Qd= f(P,Pr,Y,T)

(Note that tastes and preferences are abstract variables incapable of quantitative

measurement. For the sake of simplicity, we ignore them hereor assume them to be

unchanged. Else, we will have to take dummy variables for them, which wel take

later)

3. Specification of the model

This involves formulation of mathematical relationship among the variables, with

signs- negative/positive and values of coefficients of the variables. Signs depend on

the nature of variation of Qd with each of the regressors. It is + if variation is direct

and - if it is inverse. We can express the hypothesis as

Qd= a+bP+cPr+dY+u

Where a,b,c,d are coefficients whose values and signs we determine through collection

of data and u is a random variable representing the error term.

4. Estimation of the model

This is done through collection of statistical data for regressands and regressors.

5. Choice of appropriate economic technique

The techniques are classified into two groups:

a. Group A: Single Equation Technique: As in step 5 above, if the equation is single,

the econometric techniques employed are:

Indirect Least square or reduced form technique

Two stage least square

Limited information maximum likelihood method.

Three stage least square method

Full information maximum likelihood method.

A simultaneous system of equation can be understood by the following equations:

Qd = bo +b1P + u (Law of demand)

Qs = ao + a1P + v (Law of supply)

Qd = Qs (equilibrium market)

Whichever the form of equation, the choice of technique in each group depends on the

properties of the estimates of the coefficients. They are

1. Unbiased

2. Consistency

3. Efficiency

4. Sufficiency

Whichever technique possess most of the above properties, is considered the best

technique.

When we want to study the properties of the obtained estimators, it is convenient to

distinguish between two categories of properties: i) the small (or finite) sample

properties, which are valid whatever the sample size, and ii) the asymptotic properties,

which are associated with large samples, i.e., when tends to .

Finite Sample Properties of the OLS and ML Estimates of

Given that, as we obtained in the previous section, the OLS and ML estimates of

lead to the same result, the following properties refer to both. In order to derive these

properties, and on the basis of the classical assumptions, the vector of estimated

coefficients can be written in the following alternative form:

(2.54)

is an

means that, if we have many samples for the random variable and we calculate

the estimated value corresponding to each sample, the average of these

estimated values approaches the unknown parameter. Nevertheless, we usually

have only one sample (i.e, one realization of the random variable), so we can

not assure anything about the distance between and . This fact leads us to

employ the concept of variance, or the variance-covariance matrix if we have a

vector of estimates. This concept measures the average distance between the

estimated value obtained from the only sample we have and its expected value.

From the previous argument we can deduce that, although the unbiasedness

property is not sufficient in itself, it is the minimum requirement to be satisfied

by an estimator.

Efficiency. An estimator is efficient if it is the minimum variance unbiased

estimator. The Cramer Rao inequality provides verification of efficiency, since it

establishes the lower bound for the variance-covariance matrix of any unbiased

estimator.

A property which is less strict than efficiency, is the so called best, linear unbiased

estimator (BLUE) property, which also uses the variance of the estimators.

BLUE. A vector of estimators is BLUE if it is the minimum variance linear

unbiased estimator. To show this property, we use the Gauss-Markov Theorem.

In the MLRM framework, this theorem provides a general expression for the

variance-covariance matrix of a linear unbiased vector of estimators. Then, the

comparison of this matrix with the corresponding matrix of

conclude that

(or

allows us to

) is BLUE.

Linearity. According to (2.79) the OLS and ML estimators of

as:

and

are expressed

quadratic forms of

Unbiasedness.

Nevertheless, given that

is biased, this estimator can not be efficient, so we

focus on the study of such a property for . With respect to the BLUE

property, neither

nor

are linear, so they can not be BLUE.

Efficiency. The comparison of the variance of

element

of the matrix

(expression (2.63)) allows us to deduce

that this estimator does not satisfy the Cramer-Rao inequality, given

that

. Nevertheless, as Schmidt (1976) shows, there is no

unbiased estimator of

with a smaller variance, so it can be said that

efficient estimator.

is an

We now consider the following desirable asymptotic properties : asymptotic

unbiasedness, consistency and asymptotic efficiency.

Asymptotic unbiasedness. There are two alternative definitions of this concept.

The first states that an estimator is asymptotically unbiased if as n increases,

the sequence of its first moments converges to the parameter . It can be

expressed as:

(2.96)

Note that the second part of (2.96) also means that the possible bias of

disappears as increases, so we can deduce that an unbiased estimator is also

an asymptotic unbiased estimator.

Consistency. An estimator is said to be consistent if it converges in

probability to the unknown parameter, that is to say:

(2.99)

Means that a consistent estimator satisfies the convergence in probability to a constant,

with the unknown parameter being such a constant.

Asymptotic efficiency A sufficient condition for a consistent asymptotically

normal estimator vector to be asymptotically efficient is that its asymptotic

variance-covariance matrix equals the asymptotic Cramer-Rao lower bound

(see Theil (1971)), which can be expressed as:

(2.108)

where

denotes the so-called asymptotic information matrix, while

is the

previously described sample information matrix (or simply, information matrix).

Asymptotic Properties of the OLS and ML Estimators of

Asymptotic unbiasedness. The OLS estimator of

satisfies the finite sample

unbiasedness property, according to result (2.86), so we deduce that it is

asymptotically unbiased.

With respect to the ML estimator of , which does not satisfy the finite sample

unbiasedness (result (2.87)), we must calculate its asymptotic expectation. On

the basis of the first definition of asymptotic unbiasedness, presented in (2.96),

we have:

(2.111)

so we conclude that

is asymptotically unbiased.

and

are consistent, and given that both

are asymptotically unbiased, the only sufficient condition that we have to prove

is that the limit of their variances is null.

we conclude that both

and

are asymptotically efficient estimators of ,

so their asymptotic variances equal the asymptotic Cramer-Rao lower bound.

BLUE

An estimator, say the OLS estimator 2, is said to be a best linear unbiased

estimator (BLUE) of 2 if the following hold:

1. It is linear, that is, a linear function of a random variable, such as the

dependent variable Y in the regression model.

2. It is unbiased, that is, its average or expected value, E( 2), is equal to the

true value,

3. It has minimum variance in the class of all such linear unbiased estimators;

an unbiased estimator with the least variance is known as an efficient estimator.

Answer 6

THE METHOD OF ORDINARY LEAST SQUARES

The method of ordinary least squares is attributed to Carl Friedrich Gauss, a German

mathematician. Under certain assumptions (discussed in Section 3.2), the method of

least squares has some very attractive statistical properties that have made it one of the

most powerful and popular methods of regression analysis. To understand this method,

we first explain the leastsquares principle.

Recall the two-variable PRF: Yi = 1 + 2Xi + ui (2.4.2)

Yi = 1 + 2Xi + ui (2.6.2) = Y i + ui (2.6.3) where Y i is the estimated

(conditional mean) value of Yi.

But how is the SRF itself determined? To see this, let us proceed as follows. First,

express (2.6.3) as ui = Yi Y i = Yi 1 2Xi (3.1.1) which shows that the ui

(the residuals) are simply the differences between the actual and estimated Y values.

Now given n pairs of observations on Y and X, we would like to determine the SRF in

such a manner that it is as close as possible to the actual Y. To this end, we may adopt

the following criterion: Choose the SRF in such a way that the sum of the residuals ui

good criterion, as can be seen in the hypothetical scattergram shown in Figure 3.1. If

we adopt the criterion of minimizing ui, Figure 3.1 shows that the residuals u2 and

u3 as well as the residuals u1 and u4 receive the same weight in the sum (u1 + u2

+ u3 + u4), although the first two residuals are much closer to the SRF than the latter

two. In other words, all the residuals receive equal importance no matter how close or

how widely scattered the individual observations are from the SRF. A consequence of

this is that it is quite possible that the algebraic sum of the ui is small (even zero)

although the ui are widely scattered about the SRF.

To see this, let u1, u2, u3, and u4 in Figure 3.1 assume the values of 10, 2, +2, and

10, respectively. The algebraic sum of these residuals is zero although u1 and u4

are scattered more widely around the SRF than u2 and u3. We can avoid this

problem if we adopt the least-squares criterion, which states that the SRF can be fixed

in such a way that u2 i = (Yi Y i) 2 = (Yi 1 2Xi) 2 (3.1.2) is as small as

possible, where u2 i are the squared residuals. By squaring ui, this method gives

more weight to residuals such as u1 and u4 in Figure 3.1 than the residuals u2 and

u3. As noted previously, under the minimum ui criterion, the sum can be small even

though the ui are widely spread about the SRF. But this is not possible under the

least-squares procedure, for the larger the ui (in absolute value), the larger the u2 i .

A further justification for the least-squares method lies in the fact that the estimators

obtained by it have some very desirable statistical properties, as we shall see shortly. It

is obvious from (3.1.2) that u2 i = f( 1, 2) (3.1.3) that is, the sum of the squared

residuals is some function of the estimators 1 and 2. For any given set of data,

choosing different values for 1 and 2 will give different us and hence different

values of u2 i . To see this clearly, consider the hypothetical data on Y and X given in

the first two columns of Table 3.1.

let 1 = 1.572 and 2 = 1.357 (let us not worry right now about how we got these

values; say, it is just a guess).1 Using these values and the X values given in

column (2) of Table 3.1, we can easily compute the estimated Yi given in column (3)

of the table as Y1i (the subscript 1 is to denote the first experiment). Now let us

conduct another experiment, but this time using the values of 1 = 3 and 2 = 1.

The estimated values of Yi from this experiment are given as Y2i in column (6) of

Table 3.1. Since the values in the two experiments are different, we get different

values for the estimated residuals, as shown in the table; u1i are the residuals from the

first experiment and u2i from the second experiment. The squares of these residuals

are given in columns (5) and (8). Obviously, as expected from (3.1.3), these residual

sums of squares are different since they are based on different sets of values.

Now which sets of values should we choose? Since the values of the first

experiment give us a lower Sumu2i (= 12.214) than that obtained from the values

of the second experiment (= 14), we might say that the s of the first experiment are

the best values. But how do we know? For, if we had infinite time and infinite

patience, we could have conducted many more such experiments, choosing different

sets of s each time and comparing the resulting Sumu2i and then choosing that set

of values that gives us the least possible value of Sumu2i assuming of course that

we have considered all the conceivable values of 1 and 2. But since time, and

certainly patience, are generally in short supply, we need to consider some shortcuts to

this trialand- error process. Fortunately, the method of least squares provides us such a

shortcut. The principle or the method of least squares chooses 1 and 2 in such a

manner that, for a given sample or set of data, Sumu2i is as small as possible. In other

words, for a given sample, the method of least squares

provides us with unique estimates of 1 and 2 that give the smallest possible value of

Sumu2i . How is this accomplished? This is a straight-forward exercise in differential

calculus. As shown in Appendix 3A, Section 3A.1, the process of differentiation yields

the following equations for estimating 1 and 2:

where n is the sample size. These simultaneous equations are known as the normal

equations.

Solving the normal equations simultaneously, we obtain

where .X and .Y are the sample means of X and Y and where we define xi = (Xi .X )

and yi = (Yi-.Y). Henceforth we adopt the convention of letting the lowercase letters

denote deviations from mean values.

The last step in (3.1.7) can be obtained directly from (3.1.4) by simple algebraic

manipulations.

Incidentally, note that, by making use of simple algebraic identities, formula (3.1.6)

for estimating 2 can be alternatively expressed as

The estimators obtained previously are known as the least-squares estimators, for

they are derived from the least-squares principle. Note the following numerical

properties of estimators obtained by the method of OLS: Numerical properties are

those that hold as a consequence of the use of ordinary least squares, regardless of

how the data were generated. Shortly, we will also consider the statistical properties

of OLS estimators, that is, properties that hold only under certain assumptions about

the way the data were generated.4 (See the classical linear regression model in

Section 3.2.)

I. The OLS estimators are expressed solely in terms of the observable (i.e., sample)

quantities (i.e., X and Y). Therefore, they can be easily computed.

II. They are point estimators; that is, given the sample, each estimator will provide

only a single (point) value of the relevant population parameter. (In Chapter 5 we will

consider the so-called interval estimators, which provide a range of possible values

for the unknown population

parameters.)

III. Once the OLS estimates are obtained from the sample data, the sample regression

line (Figure 3.1) can be easily obtained. The regression line thus obtained has the

following properties:

1. It passes through the sample means of Y and X. This fact is obvious from (3.1.7), for

the latter can be written as .Y = 1 + 2.X, which is shown diagrammatically in

Figure 3.2.

the actual Y for

Yi = 1 + 2Xi

= (.Y 2.X) + 2Xi

= .Y + 2(Xi .X)

(3.1.9)

Summing both sides of this last equality over the sample values and dividing through

by the sample size n gives

.Y = .Y

(3.1.10)

where use is made of the fact that Sum(Xi .X ) = 0. (Why?)

3. The mean value of the residuals ui is zero. From Appendix 3A,

Section 3A.1, the first equation is

2Sum (Yi 1 2Xi) = 0

But since ui = Yi 1 2Xi , the preceding equation reduces to

2Sum ui = 0, whence .u = 0.

As a result of the preceding property, the sample regression

Yi = 1 + 2Xi + ui

(2.6.2)

can be expressed in an alternative form where both Y and X are expressed as

deviations from their mean values.

4. The residuals ui are uncorrelated with Xi ; that is, Sumui Xi = 0.

Answer 7

Assumption 1: Linear regression model. The regression model is linear in the

parameters, as shown in (2.4.2)

Yi = 1 + 2Xi + ui (2.4.2)

Assumption 2: X values are fixed in repeated sampling. Values taken by the

regressor X are considered fixed in repeated samples. More technically, X is assumed

to be nonstochastic

Assumption 3: Zero mean value of disturbance ui. Given the value of X, the mean,

or expected, value of the random disturbance term ui is zero. Technically, the

conditional mean value of ui is zero. Symbolically, we have

E(ui |Xi) = 0

Assumption 4: Homoscedasticity or equal variance of ui. Given the value of X, the

variance of ui is the same for all observations. That is, the conditional variances of ui

are identical.

Symbolically, we have

var (ui |Xi) = E[ui E(ui |Xi)]2

= E(ui2 | Xi ) because of Assumption 3

= 2

where var stands for variance.

Assumption 5: No autocorrelation between the disturbances. Given any two X

values, Xi and Xj (i _= j), the correlation between any two ui and uj (i _= j) is zero.

Symbolically,

cov (ui, uj |Xi, Xj) = E{[ui E(ui)] | Xi }{[uj E(uj)] | Xj }

= E(ui |Xi)(uj | Xj) (why?)

=0

where i and j are two different observations and where cov means covariance.

Assumption 6: Zero covariance between ui and Xi, or E(uiXi) = 0. Formally,

cov (ui, Xi) = E[ui E(ui)][Xi E(Xi)]

= E[ui (Xi E(Xi))] since E(ui) = 0

= E(uiXi) E(Xi)E(ui) since E(Xi) is nonstochastic (3.2.6)

= E(uiXi) since E(ui) = 0

= 0 by assumption

Assumption 7: The number of observations n must be greater than the number of

parameters to be estimated. Alternatively, the number of observations n must be

greater than the number of explanatory variables.

Assumption 8: Variability in X values. The X values in a given sample must not all

be the

same. Technically, var (X) must be a finite positive number.

Assumption 9: The regression model is correctly specified. Alternatively, there is

no

specification bias or error in the model used in empirical analysis.

Assumption 10: There is no perfect multicollinearity. That is, there are no perfect

linear

relationships among the explanatory variables.

Notable among the irrelevance-of-assumptions thesis is Milton Friedman. To him,

unreality of assumptions is a positive advantage: to be important . . . a hypothesis

must be descriptively false in its assumptions. One may not subscribe to this

viewpoint fully, but recall that in any scientific study we make certain assumptions

because they facilitate the development of the subject matter in gradual steps, not

because they are necessarily realistic in the sense that they replicate reality exactly. As

one

author notes, . . . if simplicity is a desirable criterion of good theory, all good theories

idealize and oversimplify outrageously.

Answer 8

Homoscedasticity

The first two Gauss-Markov conditions state that the disturbance terms u1, u2, ..., un

in the n observations potentially come from probability distributions that have 0 mean

and the same variance. Their actual values in the sample will sometimes be positive,

sometimes negative, sometimes relatively far from 0, sometimes relatively close, but

there will be no a priori reason to anticipate a particularly erratic value in any given

observation. To put it another way, the probability of u reaching a given positive (or

negative) value will be the same in all observations. This condition is known as

homoscedasticity, which means "same dispersion".

y = + x + u,

Heteroscedasticity

Here the variance of the potential distribution of the disturbance term is increasing as

x increases. This does not mean that the disturbance term will necessarily have a

particularly large (positive or negative) value in an observation where x is large, but it

does mean that the a priori probability of having an erratic value will be relatively

high. This is an example of heteroscedasticity, which means "differing dispersion".

If heteroscedasticity is present, the OLS estimators are inefficient because you could,

at least in principle, find other estimators that have smaller variances and are still

unbiased.

2nd Part:

Answer 17

Macro Economics

It suffers from small sample problem.

Inaccuracy brought in available data

due to frequent revisions necessitated

by estimated data differing from actual

ones.

Available data have low frequency

Data are assumed to follow normal

distribution.

Seasonability of data is not prominent.

Answer 18

Financial Econometrics

It doesnt suffer from small sample

problem.

It does not exist in Financial data.

Data do not assume to follow normal

distribution.

Seasonability of data is prominent.

A time series is a set of observations on the values that a variable takes at different

times. Such data may be collected at regular time intervals, such as daily (e.g., stock

prices, weather reports), weekly (e.g., money supply figures), monthly [e.g., the

unemployment rate, the Consumer Price Index (CPI)], quarterly (e.g., GDP), annually

(e.g., government budgets), quinquennially, that is, every 5 years (e.g., the census of

manufactures), or decennially (e.g., the census of population). Sometime data are

available both quarterly as well as annually, as in the case of the data on GDP and

consumer expenditure. With the advent of high-speed computers, data can now be

collected over an extremely short interval of time, such as the data on stock prices,

which can be obtained literally continuously (the so-called real-time quote). Although

time series data are used heavily in econometric studies, they present special problems

for econometricians. As we will show in chapters on time series econometrics later on,

most empirical work based on time series data assumes that the underlying time series

is stationary. Although it is too early to introduce the precise technical meaning of

stationarity at this juncture, loosely speaking a time series is stationary if its mean and

variance do not vary systematically over time.

2. Cross-Section Data

Cross-section data are data on one or more variables collected at the same point in

time, such as the census of population conducted by the Census Bureau every 10 years

(the latest being in year 2000), the surveys of consumer expenditures conducted by the

University of Michigan, and, of course, the opinion polls by Gallup and umpteen other

organizations. Just as time series data create their own special problems (because of

the stationarity issue), cross-sectional data too have their own problems, specifically

the problem of heterogeneity.

3. Panel Data

This is a special type of pooled data in which the same cross-sectional unit (say, a

family or a firm) is surveyed over time. For example, the U.S. Department of

Commerce carries out a census of housing at periodic intervals. At each periodic

survey the same household (or the people living at the same address) is interviewed to

find out if there has been any change in the housing and financial conditions of that

household since the last survey.

Answer 23

1. Autocorrelation

In statistics, the autocorrelation of a random process describes the correlation between values of the

process at different times, as a function of the two times or of the time lag. Let X be some repeatable

process, and i be some point in time after the start of that process. (i may be an integer for a discretetime process or a real number for a continuous-time process.) Then Xi is the value (or realization)

produced by a given run of the process at time i. Suppose that the process is further known to have

defined values for mean i and variance i2 for all times i. Then the definition of the autocorrelation

between times s and t is

where "E" is the expected value operator. Note that this expression is not well-defined for all time

series or processes, because the variance may be zero (for a constant process) or infinite. If the

function R is well-defined, its value must lie in the range [1, 1], with 1 indicating perfect correlation

and 1 indicating perfect anti-correlation.

2. Autoregression

of past values of the variable. The termautoregression indicates that it is a regression of the

variable against itself.

Thus an autoregressive model of order p can be written as

yt=c+1yt1+2yt2++pytp+et,

where c is a constant and et is white noise. This is like a multiple regression but

with lagged values of yt as predictors. We refer to this as an AR(p) model.

Autoregressive models are remarkably flexible at handling a wide range of different time

series patterns. The two series in Figure 8.5 show series from an AR(1) model and an AR(2)

model. Changing the parameters 1,,p results in different time series patterns. The

variance of the error term et will only change the scale of the series, not the patterns.

3. Partial

For a given stochastic process one is often interested in the connection between two

random variables of a process at different points in time. One way to measure a linear

relationship is with the ACF, i.e., the correlation between these two variables. Another

way to measure the connection between

and

is to filter out of

and

then calculate the correlation of the transformed random variables. This is called

the partial autocorrelation.

The partial autocorrelation of

th order is defined as

and

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