FIN 7822 Spring 2019 HW 4

Non-Linear Homework
Due: 4/4/2019

1. Let patents be the number of patents applied for by a firm during a given year. Assume
that the conditional expectation of patents given sales and RD is

𝐸 [𝑝𝑎𝑡𝑒𝑛𝑡𝑠|𝑠𝑎𝑙𝑒𝑠, 𝑅𝐷] = exp[𝛽4 + 𝛽6 log(𝑠𝑎𝑙𝑒𝑠) + 𝛽< 𝑅𝐷 + 𝛽> 𝑅𝐷< ]

where sales is annual firm sales and RD is total spending on research and development
over the past ten years
a. How would you estimate the 𝛽? ? Justify your answer by discussing the nature of
patents.
b. How would you interpret 𝛽6 ?
c. Find the partial effect of 𝑅𝐷 on 𝐸 [𝑝𝑎𝑡𝑒𝑛𝑡𝑠|𝑠𝑎𝑙𝑒𝑠, 𝑅𝐷].

2. Consider a family saving function for the population of all families in the U.S.:

𝑠𝑎𝑣 = 𝛽4 + 𝛽6 𝑖𝑛𝑐 + 𝛽< ℎℎ𝑠𝑖𝑧𝑒 + 𝛽> 𝑒𝑑𝑢𝑐 + 𝛽G 𝑎𝑔𝑒 + 𝑢

where hhsize is household size, educ is years of education of the household head, and
age is age of the household head. Assume that 𝐸 [𝑢 |𝑖𝑛𝑐, ℎℎ𝑠𝑧𝑖𝑒, 𝑒𝑑𝑢𝑐, 𝑎𝑔𝑒] = 0
a. Suppose that the sample includes only families whose head is over 25 years old.
If we use OLS on such a sample, do we get unbiased estimators of 𝛽? ? Explain.
b. Now, suppose our sample includes only married couples without children. Can
we estimate all of the parameters in the savings equation? Which ones can we
estimate?
c. Suppose we exclude from our sample families that save more than $25,000 per
year. Does OLS produce consistent estimators of 𝛽? ?

3. Evaluate the following statement: “Estimation of a Linear Probability Model is more

robust than probit or logit because the LPM does not assume homoskedasticity or a
distributional assumption.”

4. When 𝑦 is a nonnegative corner solution response with corner at zero, one strategy that
has been suggested is to use log (1 + 𝑦) as the dependent variable in a linear
regression.
a. Does the transformation log(1 + 𝑦) solve the problem of a pileup at zero?
Explain. Are there other reasons that this transformation might be useful?
b. Suppose we assume the linear model
log(1 + 𝑦) = 𝒙𝜷 + 𝑟
𝐸 [𝑟|𝒙] = 0
How would you estimate 𝜷? Generally, can 𝑟 be independent of 𝒙? Explain.
c. Show that
FIN 7822 Spring 2019 HW 4

𝐸 [𝑦|𝑥] = exp(𝐱𝛃) E[exp(r) |x] − 1

5. Some occupations, such as major league baseball, are characterized by salary floors. This
situation can be described by
𝑦 = exp(𝒙𝜷 + 𝑢)

𝑢|𝒙~𝑁𝑜𝑟𝑚𝑎𝑙(0, 𝜎 < )

𝑤 = max (𝑓, 𝑦)

where 𝑓 > 0 is the common salary floor (the minimum wage), 𝑦 is the person’s true
worth (productivity), and 𝒙 contains human capital and demographic variables.
a. Find the log-likelihood function for a random draw 𝑖 from the population
b. How would you estimate 𝐸[𝑦|𝒙]?
c. Is 𝐸[𝑤|𝒙] of much interest in this application? Explain.