Econometrics [EM2008/EM2Q05]

Lecture 5
Heteroskedasticity

Irene Mammi

irene.mammi@unive.it

Academic Year 2018/2019

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outline

I heteroskedasticity
I properties of OLS estimators
I tests for heteroskedasticity
I estimation under heteroskedasticity

I References:
I Johnston, J. and J. DiNardo (1997), Econometrics Methods, 4th
Edition, McGraw-Hill, New York, Chapter 6.

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introduction

I we assume now that the errors are nonspherical

I we consider now the model

y = X β + u with u ∼ N (0, σ2 Ω)

where Ω is a positive definite matrix of order n

I in words, we allow for heteroskedastic and/or autocorrelated
errors

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introduction (cont.)

I when heteroskedasticity alone occurs, the variance for the error vector
is  2
···

σ1 0 0
0 σ22 ··· 0
var(u ) = E(uu 0 ) =  . ..  = V
 
.. ..
 .. . . .
0 0 · · · σn2
I there are n + k unknown parameters; n unknown variances; and k
elements in the β vector
I additional assumptions are needed

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properties of OLS estimators

1. OLS estimator is unbiased and consistent:

from
b = β + (X 0 X ) −1 X 0 u
it follows directly that E(b ) = β. Mean square consistency follows
provided var(b ) has zero probability limit.
2. OLS estimator is inefficient: the generalized least squares (GLS)
estimator is the BLUE
3. conventional OLS coefficient standard errors are incorrect, and the
conventional test statistics based on them are invalid:
the correct variance matrix for the OLS coefficient vector is

var(b ) = E[(b − β)(b − β)0 ]

= E[(X 0 X )−1 X 0 uu 0 X (X 0 X )−1 ]
= σ2 (X 0 X )−1 X 0 ΩX (X 0 X )−1

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properties of OLS estimators (cont.)
which may also be expressed as
 −1   −1
σ2
 
1 0 1 0 1 0
var(b ) = (X X ) (X ΩX ) (X X )
n n n n

I when suspecting heteroskedasticity, OLS may still be used provided

that we obtain a valid estimate of the estimator variance
I White (1980) shows that what matters is obtaining a satisfactory
estimate of X 0 σ2 ΩX, which is a square matrix of order k
I let yt denote the t th observation on y, and x t0 = 1 x2t · · · xkt
 

denote the t th row of X so that can write

  σ2 0 · · · 0   · · · x 0 · · · 
.. .. ..

1 1
. . .   0 σ2 · · · 0   · · · x 0 · · · 
2 2
X 0 σ2 ΩX = 

x 1 x 2 · · · x n  

 .   
.. .. . . ..   .. 
.. .. ..  . . .   . 
. . . 0 0 ··· σ 2 ··· x 0 ···
n n
n
= ∑ σt2 x t x t0
t =1
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properties of OLS estimators (cont.)
I the White estimator replaces the unknown σt2 by et2 , where et denote
the OLS residuals
I we thus have

est.var(b ) = (X 0 X )−1 X 0 σ2 Ω̂X (X 0 X )−1

σ2 Ω̂ = diag{e12 , e22 , . . . , en2 }

I the square roots of the elements on the principal diagonal of est.

var(b ) are the estimated standard errors of the OLS coefficients, the
heteroskedasticity-consistent standard errors (HCSEs)
I the usual t and F tests are only valid asymptotically and general
linear hypotheses may be tested by the Wald statistic
a
W = (Rb − r )0 {R [est.var(b )]R 0 }−1 (Rb − r ) ∼ χ2 (q )

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tests for heteroskedasticity

the White test

I no need to specify the variables thought to determine

heteroskedasticity
I one simply computes an auxiliary regression of the squared OLS
residuals on a constant and all nonredundant variables in the set
consisting of the regressors, their squares and their cross-products
I if, for example,
xt0 = 1 x2t x3t
 

the set of nonredundant variables is

2 2
 
1 x2t x3t x2t x3t x2t x3t

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tests for heteroskedasticity (cont.)

I under the hypothesis of homoskedasticity,

a
nR 2 ∼ χ2 (q )

where q is the number of variables in the auxiliary regression

(excluding the constant)
I if homoskedasticity is rejected, there is no indication about the form
of heteroskedasticity
I a drawback is that the degrees of freedom in the χ2 (q ) test may
become rather large, which tends to reduce the power of the test

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tests for heteroskedasticity (cont.)

the Breusch-Pagan/Godfrey test

I this is an LM test
I assume
yt = x t0 β + ut i = 1, 2, . . . , n
where xt0 = 1 x2t x3t x2t 2 2
 
x3t x2t x3t , and that
heteroskedasticity takes the form

E(ut ) = 0 for all t

σt2 = E(ut2 ) = h(z t0 α)

where z t0 = 1 z2t · · · zpt is a vector of known variables,
 

α = α1 α2 · · · αp is a vector of unknown coefficients, and h(·)

is some unspecified function that must take on only positive values.

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tests for heteroskedasticity (cont.)
I the null hypothesis of homoskedasticity is then

H0 : α2 = α3 = · · · = αp = 0

this giving σt2 = h(α1 ) = constant

I the restricted model under the null is simply the usual model,
assuming normally distributed errors
I test procedure:
1. estimate the original relation by OLS; obtain the OLS residuals,
et = yt − x t0 b, and an estimated disturbance variance, σ̃2 = ∑ et2 /n.
2. regress et2 /σ̃2 on zt by OLS and compute the explained sum of
squares (ESS)
3. under H0
1 a
ESS ∼ χ2 (p − 1)
2
so that homoskedasticity is rejected if ESS/2 exceeds the preselected
critical value from the χ2 distribution

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tests for heteroskedasticity (cont.)

4. a simpler but asymptotically equivalent procedure is to regress et2 on

zt : then nR 2 from this regression is asymptotically distributed as
χ2 (p − 1) under the null
I this test requires to know the z variables causing heteroskedasticity,
though not the functional form of heteroskedasticity

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estimation under heteroskedasticity

I a first alternative is to estimate β by OLS but to compute the White

covariance matrix: however, the estimator in inefficient
I a second possibility is to compute a feasible GLS estimator: however,
this requires knowledge of the structural form of the heteroskedasticity

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estimation under heteroskedasticity (cont.)

Estimation of the heteroskedasticity relation

I assume that
σt2 = α0 + α1 ztα2 t = 1, 2, . . . , n
where z is a single variable, possibly one of the regressors, thought to
determine heteroskedasticity
I if α0 = 0 and α2 = 1, the error variance is proportional to z; if
α0 = 0 and α2 = 2, the error variance is proportional to the square of
z: in either cases, GLS reduces to weighted least squares
I for example, assume σt2 = α1 zt , then

σ12
   
··· 0 z1 ··· 0
 .. .. ..  = α  .. .. .
V = . . . 1 . . ..  = α1 Ω
0 · · · σn 2 0 · · · zn

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estimation under heteroskedasticity (cont.)
I we have
.. ..  1
 
···
 
. .  z1 0 y1 n  
. ..   ..  = 1
X 0 Ω −1 y =  ..
∑ zt x t yt

x
 1 ··· xn   .. . .  . 
.. .. 1 t =1
. . 0 ··· zn yn

I it may be seen that

n  
1
X 0 Ω −1 X = ∑ zt
x t x t0
t =1

and so " # −1 " #

n n
b GLS = ∑ x t x t0 /zt ∑ x t yt /zt
t =1 t =1
I if yt and each element in x t are all multiplied by the square root of
the reciprocal of zt , the application of OLS to the transformed
variable will give the b GLS estimator

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