Binary model

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Binary model

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Likelihood Analysis of

Binary Choice Models

Heino Bohn Nielsen

1 of 18

Introduction

In some situations, the object of interest is a binary variable:

Do married women have a paid job or not?

Which families own their own car?

Which students will pass the exam?

yi =

0 if she doesnt

Explain the choices of individuals and firms.

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(1) Interpretation of a linear regression model, yi

(3) Motivation: A latent variable model.

(4) Likelihood analysis.

(5) Measuring the goodness-of-fit.

(6) Empirical example: Teaching economics.

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Consider a linear regression

yi = x0i + i,

i = 1, 2, ..., N,

Since yi is binary, the conditional expectation can be found as

x0i = E [yi | xi] = 1 Prob(yi = 1 | xi) + 0 Prob(yi = 0 | xi)

= Prob(yi = 1 | xi).

Prob(yi = 1 | xi) = xi,

and not the change in yi.

4 of 18

Complications...

(1) Since

0 x0i 1.

(2) The error term is highly non-normal and heteroskedastic.

i,

yi

1

0

1 x0i

x0i

With Prob.

x0i

1 x0i

he variance is

2

which depends on xi and .

5 of 18

As an alternative, consider a class of models

Prob(yi = 1 | xi) = F (x0i)

for some link function F () that always lies between 0 and 1.

yi

Prob(yi=1|xi)

yi=xib

xi

6 of 18

All distribution functions are valid as link functions. Common choices are

(1) The normal distribution leading to the socalled probit model

2

t

1

exp

F (w) =

dt.

2

2

Z

ew

.

1 + ew

F (w) =

Density functions (standardized)

0.4

1.0

Normal

Logistic

Normal

Logistic

0.5

0.2

0.0

-4

-3

-2

-1

-4

-3

-2

-1

4

7 of 18

Interpretation of Coecients

The signs of the coecients are directly interpretable, but not the magnitudes.

To interpret the model we can look at the marginal eects or the slopes:

Prob(yi = 1 | xi) F (x0i)

=

= F 0 (x0i) k .

xik

xik

They depend on the values of xi. Often evaluated in

(a) the sample mean, or

(b) a standard individual defined by characteristics x.

To have the same marginal eects in a logit and probit model, the coecients have

to be dierent. Note that

1

0

Fprobit

(0) =

0.4

2

exp(0)

0

(0) =

= 0.25

Flogit

(1 + exp(0))2

so there is a scale dierence of 0.4/0.25 = 1.6.

8 of 18

An alternative is to calculate the discrete eect of a specific change:

Prob(yi = 1 | x) Prob(yi = 1 | x + ) = F (x0) F ((x + )0 ).

F ( 0 + x1 1 + x2 2 + ...xk k ) F ( 0 + (x1 + 1) 1 + x2 2 + ...xk k ).

E.g. a dummy taking values x1 = 0 versus x1 = 1.

9 of 18

A particular way to motivate the binary choice model is the so-called latent variable

representation.

Consider a woman, i, and consider her decision to work or not to work.

Assume that the utility gain from starting to work, yi, is a function of observed

characteristics, xi, and unobserved characteristics, i, i.e.

yi = x0i + i.

Note that yi is unobservable. It is called a latent variable.

Assume that the distribution of i | xi is symmetric, i.e. F ( ) = 1 F ( ).

10 of 18

0 otherwise

Prob(yi = 1 | xi) = Prob(yi > 0 | xi)

=

=

=

=

=

Prob(x0i +

> 0 | xi)

Prob( i > x0i | xi)

1 Prob( i x0i | xi)

Prob( i x0i | xi)

F (x0i) .

i

The binary choice model can therefore be written in the latent variable representation.

For the probit model that is

if yi > 0

1

0

yi = xi + i,

yi =

i N(0, 1),

if yi 0

0

For the logit model N(0, 1) is replaced by a standard logistic distribution.

11 of 18

Likelihood Analysis

We have a fully specified model and a natural estimator is maximum likelihood.

The density for the binary variable is the probability

f (yi | xi; ) = Prob(yi = 1 | xi; )yi Prob(yi = 0 | xi; )1yi .

Assuming that the individuals are independent, we have a likelihood function:

N

Y

=

Prob(yi = 1 | xi; )yi Prob(yi = 0 | xi; )1yi

i=1

N

Y

i=1

1yi

F (x0i)yi (1 F (x0i))

log L() =

N

X

i=1

The f.o.c. is s() = 0, but the likelihood equations have no analytical solution.

12 of 18

Measuring Goodness-of-fit

The idea of R2 is to compare with a model with only a constant.

Let

log L1 maximized log-likelihood function

log L0 maximized value in a model with only a constant term.

Two possible goodness-of-fit measures are

McFadden R2 = 1 log L1/ log L0

1

Pseudo R2 = 1

.

1 + 2 (log L1 log L0) /N

P

yi.

This is a simple binomial model and pbML = N1/N , where N1 =

In this case log L0 is given by

N1

N1

log L0 = N1 log

+ (N N1) log 1

.

N

N

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Predicted Values

We can construct predictions from the probabilities:

b > 1/2

ybi = 1 if F (x0i)

b 1/2.

ybi = 0 if F (x0i)

To measure the goodness-of-fit we can compare yi and ybi in a simple cross table:

yi

0

1

0

n00

n10

n0

ybi

1

n01

n11

n1

N0

N1

N

Then a simple model saying ybi = 1 for all i will have N1/N correct predictions.

To beat that we should have at least

n00 + n11 N1

>

.

N

N

14 of 18

We analyze whether a new way to teach economics (called PSI) is eective or not .

We have data for 32 classes of which 14 was exposed to PSI.

The data set includes

Variable

Mean

GRADE Whether the students grades improved, (0/1).

0.344

GPA

Grade point average.

3.117

TUCE

Pretest score, (entering knowledge of material). 21.938

0.438

PSI

Whether the class was exposed to PSI, (0/1).

Prob(GRADEi = 1 | xi) = F (x0i),

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Linear

Logit

Variable

Coe. Deriv. Coe. Deriv.

(tratio)

Constant

1.498

(2.75)

(tratio)

... 13.021

Probit

Coe. Deriv.

(tratio)

... 7.452

(2.64)

...

(2.90)

GPA

0.464

0.464

2.826

0.534

1.626

0.533

TUCE

0.010

0.010

0.095

0.018

0.052

0.017

PSI

0.379

0.379

2.379

0.449

1.426

0.468

Log-likelihood

N

PseudoR2

McFadden R2

(2.78)

(0.55)

(2.38)

12.978

32

...

...

(2.24)

(0.67)

(2.23)

12.8896

32

0.325

0.374

(2.36)

(0.64)

(2.43)

12.8188

32

0.327

0.377

Note that the results are very close (in terms of derivative).

Note the scale dierences for 4 to PSI

bLogit

2.379

=

= 1.668.

bProbit 1.426

16 of 18

Model (A)

Model (B)

Model (C)

Variable

Coe. tratio Coe. tratio Coe. tratio

Constant

13.021

2.64 10.656 2.63 0.647

1.74

GPA

2.826

2.24

2.538

2.15

...

...

TUCE

0.095

0.67

0.086

0.64

...

...

PSI

2.379

2.23

...

...

...

...

Log-likelihood

12.890

15.991

20.592

N

32

32

32

2

PseudoR

0.325

0.223

...

2

McFadden R

0.374

0.223

...

PSI is significant.

The tratio (Wald test) is 2.23 with a pvalue of 0.025 in N(0, 1).

The likelihood ratio test is

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yi

0

1

0

18

3

ybi

1

3

8

Total

21

11

32

The logit model has 26/32 = 0.813.

I.e. with GPA = 3.117 and TUCE = 21.938.

b :

The probabilities of an improvement in test scores are F (x0)

Prob(GRADE = 1 | GPA = 3.117, TUCE = 21.938, PSI = 1) = 0.5633

18 of 18

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