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Consider a linear and log-linear model. ssume for simplicity that there is only one right-

hand side variable. Additional right-hand side variables can be included in the usual way.

Y = β 0 + β1 X + U .

logY = γ 0 + γ 1 X + U .

Let ( βˆ0 , βˆ1 ) and (γˆ0 , γˆ1 ) denote the OLS estimates of ( β 0 , β1 ) and (γ 0 , γ 1 ) . Define predicted

values Yˆ = βˆ0 + βˆ1 X for the linear model and Lˆ = γˆ0 + γˆ1 X for the log-linear model. Define

residuals Û = Y = Yˆ for the linear model and Vˆ = log Y − L̂ for the log-linear model. Define the

ˆ

variables Z = Lˆ − log(Yˆ ) and W = Yˆ − e L .

To test the null hypothesis that the linear model is correct against the alternative that the

log-linear model is correct, use OLS to estimate δ 0 , δ1 , and α in the model

Û = δ 0 + δ1 X + α Z + ε1 .

Use a t-test to test the hypothesis that α = 0 . Reject the linear model if the t-test rejects this

hypothesis. Otherwise, do not reject the linear model.

To test the null hypothesis that the log-linear model is correct against the alternative that

the linear model is correct, use OLS to estimate δ 0 , δ1 , and α in the model

Vˆ = δ 0 + δ1 X + αW + ε 2 .

Use a t-test to test the hypothesis that α = 0 . Reject the log-linear model if the t-test rejects this

hypothesis. Otherwise, do not reject the log-linear model.

. * Linear model

. regress pr sqft, robust

F( 1, 98) = 28.41

Prob > F = 0.0000

R-squared = 0.4412

Root MSE = 58.773

1

------------------------------------------------------------------------------

| Robust

pr | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+-----------------------------------------------------------------------

sqft | .0838602 .0157341 5.33 0.000 .0526364 .1150841

_cons | -20.03817 17.39425 -1.15 0.252 -54.5565 14.48016

--------------------------------------------------------------------------------------

. predict phat

(option xb assumed; fitted values)

. * Log-linear model

. regress lp sqft, robust

F( 1, 98) = 59.11

Prob > F = 0.0000

R-squared = 0.4718

Root MSE = .39026

------------------------------------------------------------------------------

| Robust

lp | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+------------------------------------------------------------------------

sqft | .0005923 .000077 7.69 0.000 .0004394 .0007451

_cons | 3.569132 .0934382 38.20 0.000 3.383707 3.754557

---------------------------------------------------------------------------------------

. predict lhat

(option xb assumed; fitted values)

. gen z = lhat - log(phat)

. regress uhat sqft z, robust

F( 2, 97) = 14.76

Prob > F = 0.0000

R-squared = 0.0647

Root MSE = 57.131

2

------------------------------------------------------------------------------

| Robust

uhat | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+-----------------------------------------------------------------------

sqft | .0189792 .0191378 0.99 0.324 -.019004 .0569624

z | 92.53563 24.17651 3.83 0.000 44.55195 140.5193

_cons | -22.18754 21.34933 -1.04 0.301 -64.56005 20.18497

--------------------------------------------------------------------------------------

. * Do the PE regression for the log-linear null

. regress vhat sqft w, robust

F( 2, 97) = 0.77

Prob > F = 0.4679

R-squared = 0.0074

Root MSE = .39081

------------------------------------------------------------------------------

| Robust

vhat | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+-----------------------------------------------------------------------

sqft | .0000539 .0000807 0.67 0.506 -.0001062 .0002139

w | -.0028336 .0023562 -1.20 0.232 -.0075101 .0018428

_cons | -.0487094 .0985009 -0.49 0.622 -.2442065 .1467877

--------------------------------------------------------------------------------------

. * The PE test rejects the linear model but not the log-linear model

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