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Regression

Sample Model

2005-2007 Copyright.

Dr. Johnathan Mun.

All Rights Reserved.

Multiple Regression

This sample model illustrates how to use Risk Simulator (Enterprise Simulator) for:

1. Running a Multiple Regression Analysis

Model Background

File Name: Multiple Regression.xls

This example shows how a multiple regression can be run using Risk Simulator. The raw data are arranged in the Cross-Sectional Data worksheet,

which contains cross-sectional data on all 50 U.S. states on the number of aggravated assaults (in thousands) per year, the number of bachelor's degrees

awarded per year, police expenditure per capita population, population size in millions, population density (person per square mile), and unemployment

rate. The idea is to see if there is a relationship between the number of aggravated assaults per year and these explanatory variables using multiple

regression analysis.

Multiple Regression Analysis

To run this model, simply:

1. In the Cross Sectional Data worksheet, select the area C5:H55.

2. Select Simulation l Forecasting l Multiple Regression.

3. Choose Aggravated Assault as the dependent variable in the regression and click on OK.

Note that more advanced regressions such as lag regressors, stepwise regression, and nonlinear regressions can also be run using Risk Simulator.

For details on running such regressions as well as the results interpretation, refer to Modeling Risk, (Wiley 2006) by Dr. Johnathan Mun.

Results Summary

Refer to the Report worksheet for details on the regression output. The report has more details on the interpretation of specific statistical results.

It provides the following elements: multiple regression and analysis of variance output, including coefficients of determination, hypothesis

test results (single variable t-test and multiple variable F-test), computed coefficients for each regressor, fitted chart, and much more.

Disclaimer

DEVELOPER SPECIFICALLY DISCLAIMS ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES

OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. As standard practice for software development and end-user applications, it is important for

the Licensee to note that the valuation results attached herein are accurate to the software Developers best knowledge and are solely based on the information furnished

by the Licensee or end-user. While the software Developer has used his best efforts in preparing this report, he makes no representations or warranties with respect to

the accuracy or completeness of the contents of this model and specifically disclaims any implied warranties of merchantability of fitness for a particular purpose. The

Licensee hereby agrees that the Developer is not held liable for any loss of profit or any other commercial damages, including, but not limited to, special, incidental,

consequential or other damages. This model is only an illustration of using the software and in no way represents the correct and complete picture of an investor's

investment, risk, and return profile. The user is advised to take great care in using and interpreting the model and its results. Model was developed by Dr. Johnathan Mun

of www.realoptionsvaluation.com.

Aggravated

Assault

Bachelor's

Degree

521

367

443

365

614

385

286

397

764

427

153

231

524

328

240

286

285

569

96

498

481

468

177

198

458

108

246

291

68

311

606

512

426

47

265

370

312

222

280

759

114

419

435

186

87

188

303

102

127

251

18308

1148

18068

7729

100484

16728

14630

4008

38927

22322

3711

3136

50508

28886

16996

13035

12973

16309

5227

19235

44487

44213

23619

9106

24917

3872

8945

2373

7128

23624

5242

92629

28795

4487

48799

14067

12693

62184

9153

14250

3680

18063

65112

11340

4553

28960

19201

7533

26343

1641

Police

Expenditure Per

Capita

185

600

372

142

432

290

346

328

354

266

320

197

266

173

190

239

190

241

189

358

315

303

228

134

189

196

183

417

233

349

284

499

231

143

249

195

288

229

287

224

161

221

237

220

185

260

261

118

268

300

Population in

Millions

Population Density

(Persons/Sq Mile)

Unemployment

Rate

4.041

0.55

3.665

2.351

29.76

3.294

3.287

0.666

12.938

6.478

1.108

1.007

11.431

5.544

2.777

2.478

3.685

4.22

1.228

4.781

6.016

9.295

4.375

2.573

5.117

0.799

1.578

1.202

1.109

7.73

1.515

17.99

6.629

0.639

10.847

3.146

2.842

11.882

1.003

3.487

0.696

4.877

16.987

1.723

0.563

6.187

4.867

1.793

4.892

0.454

79.6

1

32.3

45.1

190.8

31.8

678.4

340.8

239.6

111.9

172.5

12.2

205.6

154.6

49.7

30.3

92.8

96.9

39.8

489.2

767.6

163.6

55

54.9

74.3

5.5

20.5

10.9

123.7

1042

12.5

381

136.1

9.3

264.9

45.8

29.6

265.1

960.3

115.8

9.2

118.3

64.9

21

60.8

156.3

73.1

74.5

90.1

4.7

7.2

8.5

5.7

7.3

7.5

5

6.7

6.2

7.3

5

2.8

6.1

7.1

5.9

4.6

4.4

7.4

7.1

7.5

5.9

9

9.2

5.1

8.6

6.6

6.9

2.7

5.5

7.2

6.6

6.9

7.2

5.8

4.1

6.4

6.7

6

6.9

8.5

6.2

3.4

6.6

6.6

4.9

6.4

5.8

6.3

10.5

5.4

5.1

Regression Statistics

R-Squared (Coefficient of Determination)

Adjusted R-Squared

Multiple R (Multiple Correlation Coefficient)

Standard Error of the Estimates (SEy)

nObservations

0.3272

0.2508

0.5720

149.6720

50

The R-Squared or Coefficient of Determination indicates that 0.33 of the variation in the dependent variable can be explained and accounted for by the independent variables in this

regression analysis. However, in a multiple regression, the Adjusted R-Squared takes into account the existence of additional independent variables or regressors and adjusts this RSquared value to a more accurate view of the regression's explanatory power. Hence, only 0.25 of the variation in the dependent variable can be explained by the regressors.

The Multiple Correlation Coefficient (Multiple R) measures the correlation between the actual dependent variable (Y) and the estimated or fitted (Y) based on the regression

equation. This is also the square root of the Coefficient of Determination (R-Squared).

The Standard Error of the Estimates (SEy) describes the dispersion of data points above and below the regression line or plane. This value is used as part of the calculation to obtain

the confidence interval of the estimates later.

Regression Results

Coefficients

Standard Error

t-Statistic

p-Value

Lower 5%

Upper 95%

57.9555

108.7901

0.5327

0.5969

-161.2966

277.2076

-0.0035

0.0035

-1.0066

0.3197

-0.0106

0.0036

Police

Expenditure

Per Capita

Population in

Millions

0.4644

0.2535

1.8316

0.0738

-0.0466

0.9753

25.2377

14.1172

1.7877

0.0807

-3.2137

53.6891

Degrees of Freedom

Degrees of Freedom for Regression

Degrees of Freedom for Residual

Total Degrees of Freedom

Population

Density

(Persons/Sq Unemploymen

Mile)

t Rate

-0.0086

0.1016

-0.0843

0.9332

-0.2132

0.1961

16.5579

14.7996

1.1188

0.2693

-13.2687

46.3845

Hypothesis Test

Critical t-Statistic (99% confidence with df of 44)

Critical t-Statistic (95% confidence with df of 44)

Critical t-Statistic (90% confidence with df of 44)

5

44

49

2.6923

2.0154

1.6802

The Coefficients provide the estimated regression intercept and slopes. For instance, the coefficients are estimates of the true; population b values in the following regression

equation Y = 0 + 1X1 + 2X2 + ... + nXn. The Standard Error measures how accurate the predicted Coefficients are, and the t-Statistics are the ratios of each predicted Coefficient to

its Standard Error.

The t-Statistic is used in hypothesis testing, where we set the null hypothesis (Ho) such that the real mean of the Coefficient = 0, and the alternate hypothesis (Ha) such that the real

mean of the Coefficient is not equal to 0. A t-test is is performed and the calculated t-Statistic is compared to the critical values at the relevant Degrees of Freedom for Residual. The

t-test is very important as it calculates if each of the coefficients is statistically significant in the presence of the other regressors. This means that the t-test statistically verifies

whether a regressor or independent variable should remain in the regression or it should be dropped.

The Coefficient is statistically significant if its calculated t-Statistic exceeds the Critical t-Statistic at the relevant degrees of freedom (df). The three main confidence levels used to

test for significance are 90%, 95% and 99%. If a Coefficient's t-Statistic exceeds the Critical level, it is considered statistically significant. Alternatively, the p-Value calculates each tStatistic's probability of occurrence, which means that the smaller the p-Value, the more significant the Coefficient. The usual significant levels for the p-Value are 0.01, 0.05, and

0.10, corresponding to the 99%, 95%, and 99% confidence levels.

The Coefficients with their p-Values highlighted in blue indicate that they are statistically significant at the 90% confidence or 0.10 alpha level, while those highlighted in red indicate

that they are not statistically significant at any other alpha levels.

Analysis of Variance

Regression

Residual

Total

Sums of

Squares

479388.4898

985675.1902

1465063.6800

Mean of

Squares

95877.6980

22401.7089

F-Statistic

p-Value

4.2799

0.0029

Hypothesis Test

Critical F-statistic (99% confidence with df of 4 and 3)

Critical F-statistic (95% confidence with df of 4 and 3)

Critical F-statistic (90% confidence with df of 4 and 3)

3.4651

2.4270

1.9828

The Analysis of Variance (ANOVA) table provides an F-test of the regression model's overall statistical significance. Instead of looking at individual regressors as in the t-test, the Ftest looks at all the estimated Coefficients' statistical properties. The F-Statistic is calculated as the ratio of the Regression's Mean of Squares to the Residual's Mean of Squares.

The numerator measures how much of the regression is explained, while the denominator measures how much is unexplained. Hence, the larger the F-Statistic, the more significant

the model. The corresponding p-Value is calculated to test the null hypothesis (Ho) where all the Coefficients are simultaneously equal to zero, versus the alternate hypothesis (Ha)

that they are all simultaneously different from zero, indicating a significant overall regression model. If the p-Value is smaller than the 0.01, 0.05, or 0.10 alpha significance, then the

regression is significant. The same approach can be applied to the F-Statistic by comparing the calculated F-Statistic with the critical F values at various significance levels.

Forecasting

Period

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

Actual (Y)

521

367

443

365

614

385

286

397

764

427

153

231

524

328

240

286

285

569

96

498

481

468

177

198

458

108

246

291

68

311

606

512

426

47

265

370

312

222

280

759

114

419

435

186

87

188

303

102

127

251

Forecast (F)

299.5124

487.1243

353.2789

276.3296

776.1336

298.9993

354.8718

312.6155

529.7550

347.7034

266.2526

264.6375

406.8009

272.2226

231.7882

257.8862

314.9521

335.3140

282.0356

370.2062

340.8742

427.5118

274.5298

294.7795

295.2180

269.6195

195.5955

364.5004

287.0426

431.7568

323.6399

531.4356

325.3641

192.3960

378.1250

288.6064

317.5374

355.8075

316.6280

301.1523

193.4630

327.9304

474.7332

244.3734

247.3897

326.9181

337.6402

304.5301

301.1671

287.3149

Error (E)

221.4876

(120.1243)

89.7211

88.6704

(162.1336)

86.0007

(68.8718)

84.3845

234.2450

79.2966

(113.2526)

(33.6375)

117.1991

55.7774

8.2118

28.1138

(29.9521)

233.6860

(186.0356)

127.7938

140.1258

40.4882

(97.5298)

(96.7795)

162.7820

(161.6195)

50.4045

(73.5004)

(219.0426)

(120.7568)

282.3601

(19.4356)

100.6359

(145.3960)

(113.1250)

81.3936

(5.5374)

(133.8075)

(36.6280)

457.8477

(79.4630)

91.0696

(39.7332)

(58.3734)

(160.3897)

(138.9181)

(34.6402)

(202.5301)

(174.1671)

(36.3149)

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