HOW TO DETECT MULTICOLLINEARITY?

WHAT IS MULTICOLLINEARITY?

Multicollinearity: the existence of a

perfect, or exact, linear relationship
among some or all explanatory variables
of a regression model.

Multicollinearity does not rule out nonlinear relationship among variables.

SOURCE OF MULTICOLLINEARITY:

High R-square but few significant t-ratios

High pair-wise correlation among regressors
Examination of partial correlations.
Auxiliary regressions.

IS MULTICOLLINEARITY NECESSARILY BAD?

Kleins rule of thumb

Eigenvalues and condition index

then it is not serious because high Rsquare is better.

Tolerance and variance inflation factor

Scatterplot

Data collection method. Sampling over

Constraint on the model

population being sampled.

in

of the estimators.

the

Model specification, adding polynomial

terms to a regression model, especially
when the range of the X variable is small.
An overdetermined model. The model

REMEDIAL MEASURES:

Multicollinearity

HIGH MULTICOLLINEARITY PROBLEM:

Large variance; confidence interval tend to be

much wider, leading to accept null hypothesis.

Large variance; t-ration of coefficient tends to
be statistically insignificant.
T-ratio statistically insignificant; R-square very
high

A priori information

Combining cross-sectional and time series

Dropping a variable(s) and specification bias

Transformation of variables
Additional or new data

Other methods of remedying

multicollinearity

BLUE, but OLS estimators have high/large

variance and covariance, making precise
estimation difficult

data

has more IV than the number of

observation.

If the purpose to see reliability of

parameter, it is serious because large SE

a limited range of the values by the

regressors in the population.

If the purpose is to forecast or predict,

OLS estimators and standard error can be

sensitive to changes in data

PERFECT MULTICOLLINEARITY:

Coefficient remain indeterminate and their standard

errors are infinite.

The variance and standard errors of coefficient
individually infinite.