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# OLS estimation and Monte Carlo Simulation

Athanassios Stavrakoudis
http://stavrakoudis.econ.uoi.gr

Spring 2014

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Contents

## 2 Simple Regression, use of sums and/or matrices

3 Goodness of Fit

## 5 Data Generation Processes, autocorrelation example

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Matrix Algebra

Dirk Eddelbbttel:

Econometricians sweat
linear algebra.
Dirk Eddelbbttel, Econometrics with Octave,
J. Appl. Econ., 15: 531542 (2000), doi:10.1002/1099-
1255(200009/10)15:5<531::AID-JAE573>3.0.CO;2-8

## available also: http://dirk.eddelbuettel.com/papers/octave.pdf

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Creel Econometrics
a

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Creel Econometrics
b

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Creel Econometrics
c

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Creel Econometrics
d

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Contents

## 2 Simple Regression, use of sums and/or matrices

3 Goodness of Fit

## 5 Data Generation Processes, autocorrelation example

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House prices
price sqft
199 ,9 1065
228 ,0 1254
235 ,0 1300
285 ,0 1577
239 ,0 1600
293 ,0 1750
285 ,0 1800
365 ,0 1870
295 ,0 1935
290 ,0 1948
385 ,0 2254
505 ,0 2600
425 ,0 2800
415 ,0 3000
INTRODUCTORY ECONOMETRICS WITH APPLICATIONS
Ramu Ramanathan, 5th Ed. 2002, ISBN: 0-03-034342-9
http://econweb.ucsd.edu/ rramanat/embook5.htm
HousePrices.txt
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House prices plot

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Estimation with gretl

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OLS estimation with R
3 > f <- lm (y~x)
4 > summary(f)
5

6 Call:
7 lm(formula = y ~ x)
8

9 Residuals:
10 Min 1Q Median 3Q Max
11 -53.602 -23.650 -1.192 10.948 91.898
12

13 Coefficients:
14 Estimate Std. Error t value Pr(>|t|)
15 (Intercept) 52.35091 37.28549 1.404 0.186
16 x 0.13875 0.01873 7.407 8.2e-06 ***
17 ---
18 Signif. codes: 0 *** 0.001 ** 0.01 * 0.05 . 0.1 1
19

## 20 Residual standard error: 39.02 on 12 degrees of freedom

21 Multiple R-squared: 0.8205, Adjusted R-squared: 0.8056
22 F-statistic: 54.86 on 1 and 12 DF, p-value: 8.199e-06
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Estimation of beta with simple regression

y = + x + e

n xy x y
P P P
=
n x 2 ( x )2
P P

= y x

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Simple regression with Octave

n xy x y
P P P
=
n x 2 ( x )2
P P

1 clear;
3

4 y = HousePrices(:,1); % price
5 x = HousePrices(:,2); % sqft
6 n = length(x)
7

8 sumx = sum(x);
9 sumy = sum(y);
10 sumxy = sum(x .* y);
11 sumx2 = sum(x .^ 2);
12 sum2x = sum(x) ^ 2;
13

## 14 betahat = (n*sumxy - sumx*sumy) / (n*sumx2 - sum2x)

15 alphahat = mean(y) - betahat * mean(x)
olsHousePrices1.m
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Equivalent computation with Octave

(x x )(y y ) (x x ) (y y )
P P P
=
(x x )2 ( (x x ))2
P P

1 clear;
3

4 y = HousePrices(:,1); % price
5 x = HousePrices(:,2); % sqft
6

7 xm = x - mean(x);
8 ym = y - mean(y);
9

10 sumx = sum(xm);
11 sumy = sum(ym);
12 sumxy = sum(xm .* ym);
13 sumx2 = sum(xm .^ 2);
14 sum2x = sum(xm) ^ 2;
15

## 16 betahat = (sumxy - sumx*sumy) / (sumx2 - sum2x)

olsHousePrices2.m
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calculation with matrices

y = 0 + 1 x + e (1)
y = X + e (2)
= (X 0 X )1 X 0 y (3)

1 clear;
3

4 y = HousePrices(:,1); % price
5 x = HousePrices(:,2); % sqft
6

7 T = length(x);
8 X = [ones(T,1) x];
9

10 bhat = inv(X*X)*X*y
11

olsHousePrices3.m
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Contents

## 2 Simple Regression, use of sums and/or matrices

3 Goodness of Fit

## 5 Data Generation Processes, autocorrelation example

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Estimated y and residuals

y = x
e = y y

1 bhat = inv(X*X)*X*y;
2 yhat = X*bhat;
3 ehat = y - X*bhat;
olsHousePrices4.m

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Plot of y , y vs x

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Plot of residuals

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Sum of Squares

(yi y )2
X
TSS =
(yi y )2
X
ESS =
ei2
X

1 bhat = inv(X*X)*X*y;
2 yhat = X*bhat;
3 ehat = y - yhat;
4

## 5 TSS = sumsq(y - mean(y))

6 ESS = sumsq(yhat - mean(yhat))
olsHousePrices5.m
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R2

R2 = 1
TSS

## 1 TSS = sumsq(y - mean(y));

2 ESS = sumsq(yhat - mean(yhat));
4

5 R2 = 1 - RSS/TSS
olsHousePrices6.m

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Contents

## 2 Simple Regression, use of sums and/or matrices

3 Goodness of Fit

## 5 Data Generation Processes, autocorrelation example

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has a distribution

## What is its mean?

What is its variance?
What is the shape of distribution?

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Monte Carlo Simulation of distribution

1 T = 100;
2 N = 1000;
3

4 beta = [1 1];
5 X = [ ones(T, 1), normrnd(0, 1, T, 1) ];
6 bhat1 = zeros(N, 1);
7

8 for (i = 1:N)
9 u = normrnd(0, 2, T, 1);
10 y = X*beta + u;
11 bhat = inv(X*X) * X * y;
12 bhat1(i) = bhat(2);
13 end
14

## 15 [min(bhat1) max(bhat1) mean(bhat1) var(bhat1)]

olsMC1.m
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Distribution of

y =1+x +u

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What theory tells us

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What theory tells us

## Variance of is lower when

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What theory tells us

## Variance of is lower when

1
Sample size is larger

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What theory tells us

## Variance of is lower when

1
Sample size is larger
2
Variance of explanatory variables is larger

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What theory tells us

## Variance of is lower when

1
Sample size is larger
2
Variance of explanatory variables is larger
3
Variance of error term is smaller

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What theory tells us

## Variance of is lower when

1
Sample size is larger
2
Variance of explanatory variables is larger
3
Variance of error term is smaller
4
Fewer variables are omitted

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Contents

## 2 Simple Regression, use of sums and/or matrices

3 Goodness of Fit

## 5 Data Generation Processes, autocorrelation example

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Serial autocorrelation

yt = Xt + ut
ut = ut1 + et

DGP1.m
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Serial autocorrelation

yt = Xt + ut
ut = ut1 + et

1 T = 100;
2 phi = 0.95;
3

4 u = zeros(T, 1);
5 u(1) = randn;
6

7 for (t=2:T)
8 u(t) = phi*u(t-1) + randn;
9 end
DGP1.m
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Distribution of with auto-correlated errors

yt = Xt + ut
ut = ut1 + et

MCDGP2.m
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DurbinWatson test

PT 2
t=2 (et et1 )
d= PT 2
t=1 et

MCDGP3.m
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