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# Economics Quantitatively Treated 2 (EC5002)

## (1) Show that =1 = 0, where = , = =1

and is the number of

observations.

(2) Define the population correlation coefficient and explain why it is bounded by
the values 1 and +1.
(3) Assume we have a two-asset portfolio, where the return on the portfolio, RP, is
the sum of the product of the return on each asset, R 1 and R2, multiplied their
proportionate share (weight) in the portfolio, W1 and W2, respectively. That is:
RP = W1R1 + W2R2,

Where, W1 + W2 = 1.

## (a) Specify the expected return on the portfolio.

(b) Define the variance of the return on this portfolio and show that:
p2 = W1212 + 2W1W212 + W2222
Where p2 denotes the variance of the return on the portfolio, 12 is the
variance of the return on asset 1, 22 is the variance of the return on asset 2
and 12 is the covariance of the returns on assets 1 and 2.
(c) Modify the expression of the portfolios variance derived in (3)(b) such that
the portfolios standard deviation is a function of the correlation coefficient
between assets 1 and 2.

## Econometrics exercises 3 and 4: hypothesis testing and confidence intervals

(1)

State whether the following statements are true, false, or uncertain. Justify
your answers.1
(a)
(b)

(2)

The following random sample was obtained from a normal population with
mean and variance = 2.
8, 9, 6, 13, 11, 8, 12, 5, 4, 14
(a)
(b)

(3)

## Test = 5 against 5. Use = 0.05.

Test = 5 against > 5. Use = 0.05.

## Give reasons why the following statements are false:

(a)
(b)

(4)

A type II error occurs when we reject the null hypothesis even though it
may be true.
As the degrees of freedom increase indefinitely, the t distribution
approaches the normal distribution.

## If the correlation coefficient of 2 random variables is +2 they must have

an exceptionally high positive correlation.
A variable can have a positive or negative variance.

In a random sample of rents (X, in s per week) for superior rooms in a leafy
suburb of London the following information was gathered:
n = 40
(a)
(b)

(c)
(d)

( X i X ) 2 = 5900

Xi = 7200

Construct a 95% and 99% confidence interval for the mean value of rents.
Test the hypothesis, at the 5% and 1% levels, that the true mean is 175.5.
Use both a one tailed (greater than) and 2 tailed test. Comment on the
inference drawn.
Why would a larger sample be useful?
Explain why the t table was needed.

(1)

(a)

## Specify a two-variable linear mathematical equation that represents the

stochastic Population Regression Function (PRF) for the demand of a good
represented by the function: = (), where denotes the quantity
demanded of a good and is the price of that good.
Q = f(P)

(5.1.1)

(b)

## What theoretical expectation do you have about the slope coefficient of

the PRF specified in (a)?

(c)

Specify the stochastic model that can be estimated from a sample of data,
called the stochastic Sample Regression Function (SRF).

(d)

## Write down the estimated (fitted) value of Q based on your answer to

part (c); this is called the Sample regression Line (SRL).

(e)

## Consider the general consumption function, = ( ), where

denotes consumption in time period and denotes income in time
period :
(i)

## Write down the two-variable linear mathematical equation that

represents the stochastic PRF for this relationship.
(ii) Write down the two-variable linear mathematical equation that
represents the stochastic SRF for this relationship.
(iii) Explain what slope coefficient represents and comment on any
expectations based upon economic theory that you may have about
its value.

## Econometrics exercise 7: The 2-variable LRM (derivation of OLS coefficient

estimators)

(1)

Showing all the steps of your derivation, derive OLS estimators 1 and 2 for
the following two-variable SRF:
= 1 + 2 +

(7.1.1)

(1)

## An econometrician is analysing the following population regression function:

= 1 + 2 +

(8.1.1)

where denotes the natural logarithm of the exchange rate between two
countries (number of units of foreign currency per US \$) and is the natural
logarithm of the ratio of the foreign price to the domestic (USA) price.

Summary statistics of the data are given below for three country pairings:
Canada and the USA (denoted Canada), Denmark and the USA (Denmark) and
Japan and the USA (Japan).
Canada
2
2

## = 35, = 0.21224, = 0.01765,

=1 = 0.66939,
=1 =

2
2
0.072624, =1 = 0.09434, =1 = 0.08353, =1 = 0.54685.

Denmark
2
2

## = 35, = 1.90136, = 0.01781,

=1 = 1.07190,
=1 =

2
2
0.24558,
=1 = 0.07825, =1 = 0.25668, =1 = 1.04697.

Japan

2
2
= 35, = 5.13374, = 0.25906,
=1 = 5.81281, =1 = 1.43787,

2
2

(a)

## Use the following formula to produce coefficient estimates of (8.1.1) for

all 3 country parings:
1 = 2

(8.1.2)

2 = =1
2

(8.1.3)

=1

where, =

=1

, =

=1

, = and = .

(b)

## Interpret the coefficients estimated in (a) in terms of their marginal

effects for all 3 country pairings.

(c)

Theory suggests that an increase in the relative price should raise the
exchange rate. Given this theoretical expectation, comment on whether

## the slope coefficient estimated in (a) is consistent with economic theory

for all 3 country pairings.
(d)

Specify the formula for the regression standard error (), numerically
calculate it and interpret the result for all 3 country parings.

(e)

## Use the following formula to produce estimates of the coefficient

standard errors of (8.1.1) for all 3 country parings:
2

1 = 2 ( =1

2
=1

2 = 2 (

2
=1

(2)

(8.1.4)

(8.1.5)

## An econometrician is analysing the following population regression function:

= 1 + 2 +

(8.2.1)

where denotes USA total real consumer personal expenditure and is USA
real personal disposable income (both measured in \$billions with 2009 as the
base year).
You are given the following annual data on these series from 2010 2013.
Ct
2010
2011
2012
2013

3309.2
3414.7
3515.8
3641.6

Yt
11055.1
11331.2
11676.2
11650.8

(a)

(b)

## What is the estimated value of consumption predicted by the estimated

version of (8.2.1) when income ( ) is:
(i)
(ii)

(c)

\$10000 billion
\$12000 billion

Calculate , 1 and 2 .

## Econometrics exercise 12: The 2-variable LRM (properties of OLS estimators)

(1)

Showing all the steps of your derivation, demonstrate that the OLS estimator
for the slope coefficient, 2, in the SRF given by (10.2.1) is unbiased given that
the assumptions about the LRM hold. Clearly state the assumptions that are
used in your derivation.
= 1 + 2 +

(12.1.1a)

## Econometrics exercises 13 - 14: Estimating the K-variable LRM

An econometrician is analysing the following population regression function:
= 1 + 2 2 + 3 3 +

(1)

where denotes the natural logarithm of the exchange rate between two countries
(number of units of foreign currency per US \$), 2 is the natural logarithm of the
foreign price and 3 is the natural logarithm of the domestic (USA) price.
Summary statistics of the data are given below for three country pairings: Canada
and the USA (denoted Canada), Denmark and the USA (Denmark) and Japan and the
USA (Japan).
Canada
2
= 35, = 0.21224, 2 = 4.09883, 3 = 4.08118,
=1 = 0.66939,
2

## =1 2 = 9.43680, =1 3 = 8.42514, =1 2 = 2.12630,

2
=1 3 = 2.03196, =1 2 3 = 8.89466,
=1 = 0.17165.

Denmark
2
= 35, = 1.90136, 2 = 4.06337, 3 = 4.08118,
=1 = 1.07190,
2

## =1 3 = 0.26332, =1 2 3 = 9.53321, =1 = 1.04462.

Japan
2
= 35, = 5.13374, 2 = 4.34024, 3 = 4.08118,
=1 = 5.81281,
2

## =1 3 = 6.49834, =1 2 3 = 5.46343, =1 = 0.76383.

(a)

Use the following formula to produce coefficient estimates of (1) for all 3
country parings:
1 = 2 2 3 3

(2)

=1 3 =1 2 3 =1 3
2 = =1 2
2

(3)

=1 2 =1 3 (=1 2 3 )

=1 2 =1 2 3 =1 2
3 = =1 3
2

(4)

=1 2 =1 3 (=1 2 3 )

where, = =1
, 2 =

3 = 3 3.

=1 2

, 3 =

=1 3

, = , 2 = 2 2 and

(b)

Interpret the coefficients estimated in (a) in terms of their marginal effects for
all 3 country pairings.

(c)

Theory suggests that an increase in the foreign price should raise the exchange
rate and a rise in the domestic price should reduce the exchange rate. Given
these theoretical expectations comment on whether the coefficients estimated
in (a) are consistent with economic theory for all 3 country pairings.

(d)

Specify the formula for the regression standard error (), numerically calculate
it and interpret the result for all 3 country parings.

(e)

## Use the following formula to produce estimates of the coefficient standard

errors of (1) for all 3 country parings:
1

1 = +

2
2
2

22
=1 3 +3 =1 2 22 3 =1 2 3
2

=1 2 =1 3 (=1 2 3 )

=1 3
2

2
=1 2 =1 3 (
=1 2 3 )

2 =

3 =

=1 2

=1 2 =1 3 (=1 2 3 )

(5)

(6)

(7)

Econometrics exercises 15 and 17: hypothesis testing and fit in the K-variable LRM
An econometrician is analysing the following population regression function:
= 1 + 2 2 + 3 3 +

(1)

where denotes the natural logarithm of the exchange rate between two countries,
2 is the natural logarithm of the foreign price and 3 is the natural logarithm of
the domestic (USA) price.
The table below summarises estimation results for three country pairings: Canada
and the USA (denoted Canada), Denmark and the USA (Denmark) and Japan and the
USA (Japan).
1
2
3
RSS
TSS
N

Canada
-0.857380
(0.125851)
-0.406750
(0.339787)
0.670598
(0.359609)
0.171645
0.669394
35

Denmark
2.016043
(0.407449)
0.436806
(0.571783)
-0.463000
(0.649971)
1.044620
1.071901
35

Japan
7.765857
(0.469544)
0.304484
(0.245288)
-0.968750
(0.167731)
0.763833
5.812811
35

## Coefficient standard errors ( ) are reported below estimated coefficients ( ),

RSS denotes the residual sum of squares ( 2 ), TSS the total sum of squares ( 2 )
and N the number of observations.
(1) Purchasing Power Parity (PPP) theory suggests that 2 > 0 and 3 < 0.
Comment on whether the estimated coefficients are consistent with these
theoretical expectations. How would you use information on the coefficients
statistical significance to modify this assessment of consistency with theory?
(2) For each country pairing test whether each of the coefficients are statistically
significant using a two-tailed test and a 5% level of significance. That is, test the
null hypothesis 0 : = 0 against the alternative 1 : 0, where k = 1, 2, 3.
Interpret the test results.
(3) Calculate 2 , 2 and s for each country pairing and interpret the results.
(4) Using a 5% level of significance test, for each country pairing, whether the
regression has significant explanatory power by testing the null hypothesis
0 : 2 = 0 against the alternative 1 : 2 > 0. Interpret the test results.
(5) Impose the restriction 3 = 2 on the unrestricted model, equation (1), to
derive the resulting restricted model.
(6) For each country pairing use the F-statistic to test the symmetry restriction with
a 5% level of significance. That is, test the null hypothesis 0 : 3 = 2 against
the alternative 1 : 3 2. Note that the restricted residual sum of squares
(RRSS) for Canada is 0.5468, for Denmark is 1.0470 and for Japan is 1.7896.
Interpret the test results.

## Econometrics exercise 16: an application of the 2-variable and 3-variable LRM to

PPP using EViews
Our aim is to estimate the 3-variable and 2-variable PPP LRM using E-Views. This will
involve transferring PPP data from Excel to EViews and estimating the unrestricted
and relative price versions of the PPP statistical model.
These notes are organised as follows. Section 16.1 discusses the models to be
analysed, section 16.2 outlines the transfer of data from Excel to E-Views, working in
E-Views is discussed in section 16.3 and saving the E-Views results in a Word file is
outlined in section 16.4.

## 16.1 The Models to be Analysed

As with the previous exercises the \$/ exchange rate (EA or Et) data is modelled
using US (CPA or FPt) and UK (CPU or Pt) consumer price indices, 1990~100, following
the PPP hypothesis. This exercise will focus on versions of the relative price form of
PPP. The relative price form and unrestricted form of PPP are:
Unrestricted form:

## lnEt = + lnFPt + lnPt + u2t

(16.1.1b)

Defining the variables and coefficients as: Yt = lnEt, Xt = ln(FPt / Pt), = , and =
, this can be re-expressed using the following standard two-variable LRM form:
Relative price form:

(16.1.1b)

## 16.2 Transferring data from Excel to E-Views.

This section outlines the procedure for transferring the variables EA, CPU and CPA
from the Excel file Exercise_16_EC5002_PPP_data.xls to E-Views and saving data in
an E-Views format file. Where EA denotes the UK sterling to US dollar exchange rate
(number of dollars per pound), CPA is the US consumer price index and CPU is the
consumer price index for the UK.
(1) Go on to EC5002 area on StudySpace and open the Excel data file called
Exercise_16_EC5002_PPP_data.xls.
(2) To copy the variables, EA, CPU and CPA, with their labels to the clipboard,
highlight the cell range B1:D26 and copy the selection for example, click on
the Edit menu and choose the Copy option.
(3) Open the E-Views program (you must have loaded this program from the
Kingston University Service Store to your work area). It is opened in different
ways in different labs in the University.
(4) To create a new E-Views workfile when in E-Views, click on the File menu and

## select New followed by Workfile. 2

(5) To specify the data frequency and period for the workfile, in the dialog box that
appears on the screen choose the (default) Frequency of data to be annual,
specify the Start date to be 1970 and the End date to be 1994, then click on OK.
The new workfile object should appear on the screen.
(6) To begin the transfer of the data saved in Excel to the E-Views workfile click on
the Quick menu at the very top of the screen and select the Empty Group (Edit
Series) option a spreadsheet should appear.
(7) To provide space for the variables titles press the arrow up button () on the
keyboard a second row with the title Obs should appear.
(8) To paste the data currently saved on the clipboard into E-Views click on the Edit
menu situated at the very top of the screen (do not click on the Edit +/ menu
at the top of the workfile object box) and select the Paste option. The PPP data
should now appear in the spreadsheet.
(9) To close the spreadsheet view of the data click on the situated at the top right
of the workfile object box (do not click on the situated at the top right of the
screen as this will initiate the closure of E-Views). Respond Yes when asked if
you wish to Delete Untitled Group. The workfile object box should now
include icons for the three series objects: cpa, cpu and ea.
(10) To save the transferred data click on the Save menu at the top of the workfile
object box, specify the filename for the workfile to be Exercise_16_EC5002,
select the appropriate drive and then click on the Save button. Note that the
extension for the E-Views workfile is wf1 (so your workfile is called
Exercise_16_EC5002_PPP_data.wf1).

## 16.3 Working in E-Views

This section outlines the use of E-Views for transforming variables, running a
regression and saving the results in Word.
16.3.1 Transforming and saving data
(1) To generate transformed variables (the natural logarithms), type the following
commands on the command line (the blank area at the top of the screen):
GENR LEA=LOG(EA) and then press the Enter button on the keyboard,
GENR LCPU=LOG(CPU) and then press the Enter,
GENR LCPA=LOG(CPA) and then press the Enter,
GENR LRPA=LCPALCPU and then press the Enter.
(2) To save the updated workfile click on the Save option at the top of the workfile
object box.
16.3.2 Estimating the PPP LRMs and saving the results in Word
(1) To estimate the 2-variable regression, (16.1.1a), click on the Quick menu and
2

When you first open EViews you can select the Create a new EViews workfile option that
automatically appears on the screen and then browse for the file that you wish to open.

10

## select the option Estimate Equation. Type the equation to be estimated as

LEA C LRPA in the large blank area in the dialog box that appears and click on
the OK button. Note that the term C represents the intercept in the regression.
(2) The following output should have appeared on the screen.3
(3) This output can be saved in a Word file in the following way. Highlight the
output to be saved (highlight all of the output) and copy this to the clipboard
(for example, use the Edit and Copy menus). Open the Word program and paste
the output into Word (for example, use the Edit and Paste menus). Return to
EViews (for example, click on the EViews button at the bottom of the screen).
Dependent Variable: LEA
Method: Least Squares
Sample: 1970 1994
Included observations: 25
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA

0.465626
0.670174

0.034621
0.108971

13.44909
6.150034

0.0000
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.621853
0.605412
0.123837
0.352719
17.78853
37.82292
0.000003

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.614403
0.197142
-1.263082
-1.165572
-1.236037
0.612162

(4) To save the equation as an object click on the Object button (the third button
from the left at the top of the dialog box), select Name from the menu that
appears, type in the name of the equation in the area below the title Name to
identify object as ppp_2_lrm and click on the OK button.
(5) To close the dialog box with the estimation results click on the situated at the
top right of the equation objects dialog box. An equation object should now
appear in the workfile as = ppp_2_lrm.
(6) To estimate the 3-variable regression, (16.1.1b), double click on the equation
object, = ppp_2_lrm.
(7) Click on the Object button and select Copy object from the menu that
appears. In the new object dialog box that appears click on the Object button,
select Name from the menu that appears, type in the name of the equation in
the area below the title Name to identify object as ppp_3_lrm and click on the
OK button.
(8) Click on the Estimate button situated as seventh from the left on the menu bar
at the top of the object dialog box. Type the equation to be estimated as LEA C
LCPA LCPU in the large blank area in the dialog box that appears and click on the
OK button.
(9) The following output should have appeared on the screen.
(10) This output can be added to the Word file by highlighting and copying the
output to be saved and pasting it into Word. Return to EViews (for example,
3

11

## click on the EViews button at the bottom of the screen).

Dependent Variable: LEA
Method: Least Squares
Sample: 1970 1994
Included observations: 25
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LCPA
LCPU

0.937511
0.375168
-0.478546

1.040684
0.659616
0.436688

0.900860
0.568767
-1.095853

0.3774
0.5753
0.2850

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.625358
0.591300
0.126032
0.349449
17.90494
18.36139
0.000020

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.614403
0.197142
-1.192395
-1.046130
-1.151828
0.622585

(11) To close both of the dialog boxes containing the estimation results click on the
situated at the top right of both of the equation objects dialog boxes. Another
equation object should appear in the workfile as = ppp_3_lrm.
(12) To save the updated workfile click on the Save option at the top of the workfile
object box.
(13) To exit E-Views, click on the File menu, choose Exit and click on OK when told
that all unsaved data will be lost (you have already saved your data in
Exercise_16_EC5002_PPP_data.wf1).
16.4 Saving the E-Views results (computer output) in a Word file
(1) To save the EViews computer output that you pasted in to the Word document
Exercise_16_EC5002 click on the File menu, choose the Save As option and
select the Word Document option in the Save as type: area, type in the name of
the document as Exercise_16_EC5002 and navigate to the drive where you want
to save the file. Click on Save.
(2) Exit Word (shut down Excel if necessary) and shut down the computer.

12

## Econometrics exercise 19. Autocorrelation on E-Views

Our aim is to test whether the estimates of the 2-variable relative price form of the
PPP model are valid using E-Views. This will involve testing whether the assumption
that the linear regression models (LRM) residuals from evident serial correlation
(autocorrelation). An autoregressive distributed lag (ADL) model that overcomes
autocorrelation will also be estimated.
19.1 Working in E-Views
This section outlines the use of E-Views for running a static regression, testing for
autocorrelation, overcoming autocorrelation using an ADL model, estimating a
parsimonious ADL model and saving the results in a Word document.
19.2 Open a workfile, open the existing 2-variable PPP LRM model and save the
results
(1) Enter Eviews and load the workfile Exercise_16_EC5002_PPP_data.wf1 that was
saved in the previous exercise. That is, click on the File menu, and select the
option
Open
followed
by
Workfile,
choose
the
file
4
Exercise_16_EC5002_PPP_data.wf1 and click on the Open button.
(2) To apply autocorrelation tests to the 2-variable PPP LRM open the object where
this equations estimation results are stored by double clicking on the equation
object, = ppp_2_lrm. The following output should have appeared on the
screen.5 Identify the DW statistic that tests for first-order autocorrelation on this
output.

## Dependent Variable: LEA

Method: Least Squares
Sample: 1970 1994
Included observations: 25
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA

0.465626
0.670174

0.034621
0.108971

13.44909
6.150034

0.0000
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.621853
0.605412
0.123837
0.352719
17.78853
37.82292
0.000003

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.614403
0.197142
-1.263082
-1.165572
-1.236037
0.612162

(3) This output can be saved in a Word file in the following way. Highlight the
4

When you first open EViews you can select the Open an existing EViews file option that
automatically appears on the screen and then browse for the file that you wish to open.
5
Do not worry if there are minor discrepancies with your results.

13

output to be saved (highlight all of the output) and copy this to the clipboard
(for example, use the Edit and Copy menus). Go to the desktop, open the Word
program and paste the output into Word (for example, use the Edit and Paste
menus). Return to EViews (for example, click on the EViews button at the
bottom of the screen).
19.3 Testing the estimated LRM for 1st-order autocorrelation using the BreuschGodfrey test
(1) To test the estimated PPP LRM for 1storder autocorrelation, click on the View
menu, select the option Residual Tests and then choose Serial Correlation LM
Test. When prompted to specify the Lags to include type 1 and click on the OK
button.
(2) This output can be added to the Word file by highlighting and copying the
output to be saved and pasting it into Word. Return to EViews (for example,
click on the EViews button at the bottom of the screen). The following output
should have appeared on the screen.6 Is there evidence of first-order
autocorrelation?
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

19.77152
11.83313

Prob. F(1,22)
Prob. Chi-Square(1)

0.0002
0.0006

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Sample: 1970 1994
Included observations: 25
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA
RESID(-1)

-0.002141
0.005485
0.689207

0.025695
0.080869
0.154999

-0.083321
0.067825
4.446518

0.9343
0.9465
0.0002

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.473325
0.425446
0.091891
0.185768
25.80319
9.885761
0.000865

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

## Do not worry if there are minor discrepancies with your results.

14

7.05E-17
0.121230
-1.824255
-1.677990
-1.783687
1.268535

19.4 Testing the estimated LRM for 2nd-order autocorrelation using the BreuschGodfrey test
(1) To test the estimated PPP LRM for 2ndorder autocorrelation, click on the View
menu, select the option Residual Tests and then choose Serial Correlation LM
Test. When prompted to specify the Lags to include type 2 and click on the OK
button. Is there evidence of second-order autocorrelation?
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

16.76415
15.37197

Prob. F(2,21)
Prob. Chi-Square(2)

0.0000
0.0005

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Sample: 1970 1994
Included observations: 25
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA
RESID(-1)
RESID(-2)

0.001521
-0.005002
1.045375
-0.521439

0.022528
0.070881
0.186652
0.187686

0.067500
-0.070568
5.600651
-2.778250

0.9468
0.9444
0.0000
0.0113

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.614879
0.559862
0.080427
0.135839
29.71600
11.17610
0.000136

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

7.05E-17
0.121230
-2.057280
-1.862260
-2.003190
2.278805

(2) To save the output that appears on the screen (above) in Word, highlight and
copy the output to be saved and paste it into Word. Return to EViews (for
example, click on the EViews button at the bottom of the screen).
(3) To close the dialog box containing the estimation results click on the situated
at the top right of the equation objects dialog box.

## 19.5 Estimating a general ADL (2, 2) PPP LRM

(1) To estimate the regression Yt = 0+ 0Xt+ 1Xt1+ 2Xt2 + 1Yt1 + 2Yt2 +
ut, click on the Quick menu and select the option Estimate Equation. Type the
equation to be estimated as LEA C LRPA LRPA(1) LRPA(2) LEA(1) LEA(2) in
the large blank area in the dialog box that appears and click on the OK button.
(2) Click on the button Name at the top of the dialog box containing the estimation
results and type PPP_ADL_general, this creates an equation object in the
workfile.
(3) This output can be added to the Word file by highlighting and copying the
15

output to be saved and pasting it into Word. Return to EViews (for example,
click on the EViews button at the bottom of the screen).
Dependent Variable: LEA
Method: Least Squares
Sample (adjusted): 1972 1994
Included observations: 23 after adjustments
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA
LRPA(-1)
LRPA(-2)
LEA(-1)
LEA(-2)

0.227545
-0.048926
0.660527
-0.304550
1.089954
-0.569411

0.077462
0.777823
1.229136
0.694393
0.200017
0.201803

2.937500
-0.062902
0.537392
-0.438585
5.449296
-2.821616

0.0092
0.9506
0.5980
0.6665
0.0000
0.0118

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.845040
0.799463
0.084044
0.120076
27.79831
18.54109
0.000002

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.590984
0.187675
-1.895506
-1.599290
-1.821008
2.079239

## Breusch-Godfrey Serial Correlation LM Test:

F-statistic
Obs*R-squared

0.308463
0.435029

Prob. F(1,16)
Prob. Chi-Square(1)

0.5863
0.5095

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Sample: 1972 1994
Included observations: 23
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA
LRPA(-1)
LRPA(-2)
LEA(-1)
LEA(-2)
RESID(-1)

-0.030439
0.189730
-0.389966
0.167270
0.177906
-0.114000
-0.279803

0.096221
0.864501
1.437999
0.770281
0.379882
0.290831
0.503792

-0.316343
0.219468
-0.271186
0.217154
0.468319
-0.391980
-0.555395

0.7558
0.8291
0.7897
0.8308
0.6459
0.7002
0.5863

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.018914
-0.348993
0.085807
0.117805
28.01791
0.051411
0.999265

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

16

-2.55E-16
0.073878
-1.827645
-1.482059
-1.740731
1.932099

(1) To test the estimated ADL PPP LRM for 1storder autocorrelation, click on the
View menu, select the option Residual Tests and then choose Serial Correlation
LM Test. When prompted to specify the Lags to include type 1 and click on the
OK button.
(2) This output (above) can be added to the Word file by highlighting and copying
the output to be saved and pasting it into Word. Return to EViews (for example,
click on the EViews button at the bottom of the screen). Does this model exhibit
evident first-order autocorrelation?
(3) To test the estimated PPP LRM for 2ndorder autocorrelation, click on the View
menu, select the option Residual Tests and then choose Serial Correlation LM
Test. When prompted to specify the Lags to include type 2 and click on the OK
button.
(4) To save the output (below) that appears on the screen in Word, highlight and
copy the output to be saved and paste it into Word. Return to EViews (for
example, click on the EViews button at the bottom of the screen). Does this
model exhibit evident second-order autocorrelation?
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

0.822988
2.274269

Prob. F(2,15)
Prob. Chi-Square(2)

0.4580
0.3207

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Sample: 1972 1994
Included observations: 23
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA
LRPA(-1)
LRPA(-2)
LEA(-1)
LEA(-2)
RESID(-1)
RESID(-2)

0.090416
0.189239
-0.611346
0.539448
-0.107589
-0.096862
0.023231
0.518455

0.141575
0.855692
1.436221
0.827866
0.450129
0.288250
0.563602
0.449367

0.638645
0.221153
-0.425663
0.651613
-0.239019
-0.336033
0.041220
1.153745

0.5327
0.8280
0.6764
0.5245
0.8143
0.7415
0.9677
0.2667

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.098881
-0.321641
0.084933
0.108203
28.99567
0.235139
0.969672

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

-2.55E-16
0.073878
-1.825711
-1.430756
-1.726381
1.946445

## 19.7 Testing for redundant variables in the general ADL(2, 2) model

(1) To test whether the two variables, LRPA and LRPA(2), that appear most
individually insignificant in the ADL(2, 2), are jointly insignificant click on the

17

View menu, select the option Coefficient Diagnostics and then choose
Redundant Variables Test Likelihood Ratio. When prompted to specify the
variables to be deleted from the model type LRPA LRPA(2) in the OmittedRedundant Variable Test dialog box and then click the OK button.
(2) To save the output that appears on the screen (below) in Word, highlight and
copy the output to be saved and paste it into Word. Return to EViews (for
example, click on the EViews button at the bottom of the screen). Are the
variables LRPA and LRPA(-2) jointly insignificant? In the Restricted Test Equation
(that reports the ADL(2, 2) model with LRPA and LRPA(-2) excluded) reported in
the output below are there any further variables that might be considered for
deletion from the model?
(3) To close the dialog box containing the estimation results click on the situated
at the top right of the equation objects dialog box.
Redundant Variables Test
Equation: PPP_ADL_LEVELS_GEN
Specification: LEA C LRPA LRPA(-1) LRPA(-2) LEA(-1) LEA(-2)
Redundant Variables: LRPA LRPA(-2)

F-statistic
Likelihood ratio

Value
0.105152
0.282782

df
(2, 17)
2

Probability
0.9008
0.8681

Sum of Sq.
0.001485
0.121562
0.120076
0.120076

df
2
19
17
17

Mean
Squares
0.000743
0.006398
0.007063
0.007063

Value
27.65692
27.79831

df
19
17

F-test summary:

Test SSR
Restricted SSR
Unrestricted SSR
Unrestricted SSR
LR test summary:
Restricted LogL
Unrestricted LogL

## Restricted Test Equation:

Dependent Variable: LEA
Method: Least Squares
Sample: 1972 1994
Included observations: 23
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA(-1)
LEA(-1)
LEA(-2)

0.226558
0.293964
1.100390
-0.586239

0.073589
0.129579
0.186584
0.183547

3.078704
2.268608
5.897564
-3.193952

0.0062
0.0351
0.0000
0.0048

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.843123
0.818353
0.079987
0.121562
27.65692
34.03790
0.000000

18

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.590984
0.187675
-2.057124
-1.859646
-2.007459
2.181380

## 19.8 Estimating a parsimonious ADL PPP LRM

(1) To estimate the parsimonious regression Yt = 0+ 0Xt-1+ 1Yt1 + 2Yt2 + ut,
click on the Estimate menu and specify the equation to be estimated as LEA C
LRPA(1) LEA(1) LEA(2) in the dialog box that appears and click on the OK
button.
(2) Click on the button Name at the top of the dialog box containing the estimation
results and type PPP_ADL_specific, this creates an equation object in the
workfile.
(3) To save the output that appears on the screen in Word, highlight and copy the
output to be saved and paste it into Word. Return to EViews (for example, click
on the EViews button at the bottom of the screen).
Dependent Variable: LEA
Method: Least Squares
Sample (adjusted): 1972 1994
Included observations: 23 after adjustments
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA(-1)
LEA(-1)
LEA(-2)

0.226558
0.293964
1.100390
-0.586239

0.073589
0.129579
0.186584
0.183547

3.078704
2.268608
5.897564
-3.193952

0.0062
0.0351
0.0000
0.0048

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.843123
0.818353
0.079987
0.121562
27.65692
34.03790
0.000000

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.590984
0.187675
-2.057124
-1.859646
-2.007459
2.181380

## 19.9 Testing for autocorrelation in the parsimonious ADL PPP LRM

(1) To test the estimated PPP LRM for 1storder autocorrelation, click on the View
menu, select the option Residual Tests and then choose Serial Correlation LM
Test. When prompted to specify the Lags to include type 1 and click on the OK
button.
(2) To save the output that appears on the screen (below) in Word, highlight and
copy the output to be saved and paste it into Word. Return to EViews (for
example, click on the EViews button at the bottom of the screen). Does this
model exhibit evident first-order autocorrelation?

19

## Breusch-Godfrey Serial Correlation LM Test:

F-statistic
Obs*R-squared

1.061349
1.280656

Prob. F(1,18)
Prob. Chi-Square(1)

0.3166
0.2578

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Sample: 1972 1994
Included observations: 23
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA(-1)
LEA(-1)
LEA(-2)
RESID(-1)

-0.046741
-0.059805
0.288000
-0.187447
-0.441727

0.086350
0.141798
0.335933
0.258237
0.428770

-0.541299
-0.421762
0.857313
-0.725872
-1.030218

0.5949
0.6782
0.4025
0.4772
0.3166

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.055681
-0.154168
0.079859
0.114793
28.31577
0.265337
0.896369

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

-4.65E-17
0.074334
-2.027458
-1.780612
-1.965377
1.874221

(3) To test the estimated PPP LRM for 2ndorder autocorrelation, click on the View
menu, select the option Residual Tests and then choose Serial Correlation LM
Test. When prompted to specify the Lags to include type 2 and click on the OK
button.
(4) To save the output that appears on the screen in Word, highlight and copy the
output to be saved and paste it into Word. Return to EViews (for example, click
on the EViews button at the bottom of the screen). Does this model exhibit
evident second-order autocorrelation?
(5) To close the regression / test output view click on the situated at the top right
of the equation object box (do not click on the situated at the top right of the
screen as this will initiate the closure of E-Views).

20

## Breusch-Godfrey Serial Correlation LM Test:

F-statistic
Obs*R-squared

0.703920
1.759050

Prob. F(2,17)
Prob. Chi-Square(2)

0.5085
0.4150

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Sample: 1972 1994
Included observations: 23
Presample missing value lagged residuals set to zero.
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LRPA(-1)
LEA(-1)
LEA(-2)
RESID(-1)
RESID(-2)

0.020435
0.031380
0.102049
-0.143274
-0.226462
0.255416

0.139667
0.206245
0.455156
0.272305
0.558031
0.412778

0.146310
0.152152
0.224207
-0.526154
-0.405824
0.618772

0.8854
0.8809
0.8253
0.6056
0.6899
0.5443

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.076480
-0.195143
0.081264
0.112265
28.57190
0.281568
0.916806

## Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

-4.65E-17
0.074334
-1.962774
-1.666558
-1.888277
1.854927

## 19.10 Saving your work and exiting E-Views

(3)
(4)
(5)

Save the updated Eviews workfile by clicking on the Save menu at the top of
the workfile dialog box and exit EViews.
Save the updated Word file containing the computer output produced and
close Word.
Logoff and/or shutdown the computer.

21

## Econometrics exercises 20: autocorrelation (Durbin-Watson test)

(1)

(a) Prove that the two expressions for the Durbin-Watson d-statistic (given
below) are approximately equivalent. State any necessary assumptions.
T

d = (et - et-1)

t=2

/ et2
t=1

2(1 - )
^

where et is the residual from the estimated LRM and is the estimated
autocorrelation coefficient.

(b) Using your answer to Question 1a specify the values of d that correspond
to the estimated value of being 1, 0 and 1.

## (c) Given the following Durbin-Watson d-statistic, d = 0.3875, test whether

the residuals exhibit statistically significant autocorrelation at the 5% level.
Assume that the residuals are from a two-variable LRM estimated using 6
observations of data.

(d) The following model is estimated where coefficient standard errors are
specified in brackets and standard statistics are given (T is the sample size):
^
Yt = 0.674 + 0.996X2t + 0.136X3t
(0.311) (0.442) (0.097)
R2 = 0.341, AdjR2 = 0.225, s = 0.1993, d = 2.403, T = 60.
Test whether the model features statistically significant first-order
autocorrelation at the 5% level. Discuss the inference that you would
draw.

autocorrelation.

22

(1)

## (a) The following model is estimated:

^
Yt = 0.674 + 0.996X2t + 0.136X3t
(0.311) (0.442) (0.097)
R2 = 0.341, AdjR2 = 0.225, s = 0.1993, d = 2.403, T = 60.
The estimated residuals, et, are collected from this model and the value
preceding the first observation of the sample is set equal to zero. Using this
residual series, the following auxiliary regression is estimated over the full
sample of 60 observations:
et = 0.013 + 0.034X2t + 0.021X3t 0.032et-1 + vt
(0.062) (0.036) (0.035) (0.012)
R2 = 0.090, AdjR2 = 0.061, s = 0.0112, d = 1.983, T = 60.
Use the Breusch-Godfrey LM test to determine whether there is evidence
of statistically significant autocorrelation at the 5% level.

(b) Why is the first observation of the residual series used in Question 2a set
equal to zero?

(c) The estimated residuals, et, are collected from the model estimated in
Question 1(a) and the two values preceding the first observation of the
sample are set equal to zero. Using this residual series, the following
auxiliary regression is estimated over the full sample of 60 observations:
et = 0.011 + 0.025X2t + 0.017X3t 0.030et-1 + 0.004et-2 + vt
(0.062) (0.036) (0.035) (0.012)
(0.010)
R2 = 0.096, AdjR2 = 0.057, s = 0.0113, d = 1.897, T = 60.
Use the Breusch-Godfrey LM test to determine whether there is evidence
of statistically significant autocorrelation at the 5% level.

(d) Why are the first two values of the residual series set equal to zero?

23

## Econometrics exercises 22: autocorrelation (GLS estimator)

(1) Assume the following two-variable LRM with AR(1) error process where is
known.

Yt X t ut

(22.1.1)

ut ut 1 vt

(22.1.2)

where, E (vt ) 0 , E (vt2 ) v2 , and E (vt vt i ) 0 . That is, vt is white noise (in
particular, non-autocorrelated).
By applying the Generalised Least Squares (GLS) estimator show that it produces BLU
coefficient estimates.

(1)

## Using an equation to illustrate your answer explain how the respecification

approach to overcoming autocorrelation utilises an autoregressive distributed
lag model.

(2)

Show that the following two-variable LRM with AR(1) error process is
equivalent to an ADL(1, 1) model assuming the common factor restriction holds
and specify the appropriate common factor restriction.

Yt X t ut

(23.2.1)

ut ut 1 vt

(23.2.2)

Based upon this result comment on whether the ADL(1, 1) model or twovariable LRM with AR(1) error process is more general.

24