SBR Tutorial 4

Fall 2017

(1)
You have the following regression result.
^
ln ⁡( Earnings)=3.86−0.28 × Female+ 0.37 ln ( MarketValue )+ 0.35 Return
(0.03) (0.4) (0.004) (0.2)
2
n=46670 , Ŕ =0.345

The used variables are defined as follow:

ln ⁡( Earnings): Logarithm of earnings per hour
Female: Dummy variable indicates 1 if the worker is female, otherwise 0.
ln ( MarketValue ): Logarithm of the market value of the firm (a measure of firm size,
in millions of dollars)
Return: Stock returns (a measure of firm performance, in percentage points).

(a) What is the dependent variable?

(b) What are independent variables (or explanatory variables)?
(c) Which independent are statistically significant in explaining workers’ earnings?
Use t-test (two-sided test) to justify your answers (Compute t-statistic, p-value).
(d) Look at the signs of estimated coefficients, discuss if they are positively or
negatively associated with earnings.
(e) The coefficient on ln(MarketValue) is 0.37. Explain what this value means.
(f) The coefficient on Return is 0.35. Explain what this value means.

Solution:
(a) ln ⁡( Earnings)
(b) Female, ln ( MarketValue ), and Return
(c)
In terms of the variable of Female,
t-statistic = 0.28/0.4=0.7 and p-value = 2 Φ (−|t |) =2Φ (−0.7 )=2 × 0.242=0.484 .
Therefore, Female is not statistically significant.

In terms of the variable of ln ( MarketValue ),

t-statistic = 0.37/0.004=92.5 and p-value = 2 Φ (−|t |) ≈ 0
Therefore, ln ( MarketValue ) is statistically significant at 1% level.
In terms of the variable of Return,
t-statistic = 0.35/0.2=1.75 and p-value = 2 Φ (−|t |) =2× 0.0401=¿0.0802
Therefore, Return is statistically significant at 10% level.

(d) Female is negatively related to earnings but not significant.

Firm size is positively significant associated with earnings.
Firm return is positively significant associated with earnings.

(e) It indicates that if MarketValue increases by 1%, earnings increase by 0.37%.

(f) It indicates that if Return increases by one unit earnings increase by 35%.

(2)
Consider the regression model Y i=β 0 + β 1 X 1 i+ β 2 X 2 i + β3 ( X 1i × X 2i ) +u i. Use Key
Concept 8.1 to show:
a. ∆ Y /∆ X 1=β 1 + β 3 X 2 (effect of change in X1, holding X2 constant).
b. ∆ Y /∆ X 2=β 2 + β 3 X 1 (effect of change in X2, holding X1 constant).
c. If X1 changes by ∆ X 1 and X2 changes by ∆ X 2, then
∆ Y =( β 1+ β3 X 2 ) ∆ X 1+ ( β2 + β 3 X 1 ) ∆ X 2 + β 3 ∆ X 1 ∆ X 2

Solution:
(a) ∆ Y =f ( X 1+ ∆ X 1 , X 2 )−f ( X 1 , X 2 )=β 1 ∆ X 1 + β 3 ∆ X 1 X 2

So, ∆ Y =β 1+ β3 X 2
∆ X1
(b) ∆ Y =f ( X 1 , X 2 + ∆ X 2 )−f ( X 1 , X 2 )=β 2 ∆ X 2 + β 3 X 1 ∆ X 2

So, ∆ Y =β 2 + β 3 X 1
∆ X2
(c) ∆ Y =f ( X 1+ ∆ X 1 , X 2+ ∆ X 2 ) −f ( X 1 , X 2 )
¿ β 0 + β 1 ( X 1+ ∆ X 1 ) + β 2 ( X 2+ ∆ X 2 ) + β 3 (X 1+ ∆ X 1) ( X 2+ ∆ X 2 )
−¿+β 1 X 1+β 2 X 2+β 3 X 1 X 2
=(β 1+ β3 X 2)∆ X 1+( β 2 + β 3 X 1) ∆ X 2+ β3 ∆ X 1 ∆ X 2

(3)
In macroeconomics, the per capita income depends on the savings rate of the country:
those who save more end up with a higher standard of living. To test this theory, you
collect data from the Penn World Tables on GDP per worker relative to the United
States (RelProd) in 1990 and the average investment share of GDP from 1980-1990
(SK), remembering that investment equals saving. The regression results in the
following output:

= –0.08 + 2.44×SK, R2=0.46, SER = 0.21

(0.04) (0.38)

(a) Interpret the regression results carefully.

(b) Calculate the t-statistics to determine whether the two coefficients are
significantly different from zero. Justify the use of a one-sided or two-sided test.

(c) You accidentally forget to use the heteroskedasticity-robust standard errors option
in your regression package and estimate the equation using homoskedasticity-only
standard errors. This changes the results as follows:
= -0.08 + 2.44×SK, R2=0.46, SER = 0.21

(0.04) (0.26)

You are delighted to find that the coefficients have not changed at all and that your
results have become even more significant. Why haven't the coefficients changed?
Are the results really more significant? Explain.

(d) Is it likely that the error terms would be heteroskedastic in this situation?

Solution:
(a) An increase in the saving rate of 10%, results in an increase in relative GDP
per worker of 24.4%. There is no interpretation for the intercept. The
regression explains 46 percent of the variation in GDP per worker relative to
the United States.
(b) The t- statistics are -2.00 (-0.08/0.04) and 6.42 (2.44/0.38) for the intercept
and slope respectively. You should use a two-sided test for the intercept, since
there are no prior expectations on whether it should be positive or negative.
Hence the intercept is statistically significant at the 5 percent level, but not at
 the 1 percent level. Since we expect a positive sign on the slope, we should
conduct a one-sided test. The critical values suggest significance at any
reasonable probability level of the size of the test.

(c) Whether you use homoskedasticity-only or heteroskedasticity-robust standard

errors does not affect the estimator, only the formula for the standard errors.
• If the assumption of homoskedasticity was valid, then the results would be
more significant.
• However, given the lengthy discussion on homoskedasticity versus
heteroskedasticity in the textbook, it is safer to conduct inference under the
assumption of heteroskedasticity.

(d) Since economic theory does not suggest, in general, that errors are homoskedastic,
it is safer to assume that they are not. This avoids invalid statistical inference.