University of Geneva Bachelor in Economics

Econometrics Fall 2021

Prof. Jaya Krishnakumar & Tobias Müller

Exam session August 2021

Duration of the exam: 2 hours on TestWe
Open-book

Exercise 1 : Derivation question (20 points)

Consider the following time series regression model

yt = x0t β1 + εt , t = 1, ..., T1 (1)

yt = x0t β2 + εt , t = T1 + 1, ..., T1 + T2 = T (2)

where x0t is a (K × 1) vector of explanatory variables, assumed to be exogenous. It is also

assumed that T1  K, T2  K.
Note that the model is postulating a structural change at T1 for the response coefficient.
The assumptions on εt are as follows :

εt = λεt−1 + ut , ∀t (3)

with
| λ |< 1; ut ∼ iid(0, σu2 ).
1. Piling the observations over time, write the model in compact form as :

y = Xβ + ε (4)
" #
β1
where β = .
β2
Give the dimensions and content of y, X, ε.
2. Give the content of the variance covariance matrix of ε, denoted as Σ.
3. Based on the above answer, estimate β by an appropriate method (denoting the
estimator as β̂) and give its analytical expression. Justify your method.
4. Show that the estimator is unbiased under X fixed and Σ known. Calculate its
variance V (β̂) keeping X fixed and Σ known.
5. How would you estimate λ ? Describe the procedure in detail. Justify each step.
6. Propose a suitable estimator of σu2 , justifying your answer. Give its analytical ex-
pression explaining the content of the vectors and matrices involved in it.
7. Propose a test for testing H0 : β1 = β2 , justifying the principle of the test. Give
the expression of the test statistic and state its distribution under H0 .
8. Suppose Σ = σu2 IT (that is, no autocorrelation). Using this information in β̂ of
point 3., derive β̂1 and β̂2 giving two separate expressions for them. What do you
conclude from the result ?
Econometrics, Fall 2021 2

Exercise 2 (20 points)

The following (simplified) model captures the main long-run determinants of institutions
and economic development of countries that were former colonies :
logGDPi = α0 + α1 geographyi + α2 smortalityi + ui1 (5)
institutionsi = γ0 + γ1 geographyi + γ2 smortalityi + ui2 (6)
where

logGDPi : logarithm of GDP per capita in 1995 of country i.

institutionsi : indicator of expropriation risk, average 1985–95 (scale from 0 to 10).
geographyi : latitude (absolute value) of country i (scaled to take values between 0 and 1)
smortalityi : logarithm of settler mortality during early 19th century in country i.
The stochastic assumptions are

E(ui1 ) =  E(ui2 ) = 0 ∀i
ρii

 i = j, k = l

0 i 6= j, k = l

E(uik ujl ) =


 ρ
 ij
i = j, k 6= l
i 6= j, k 6= l


0
1. Propose an estimation method for the model and justify your choice. Describe in
detail the steps of the estimation method.
2. To answer questions 2 to 5, please refer to the Stata output given in Tables 1 and 2.
We begin to estimate each equation separately by Ordinary Least Squares (OLS).
Then, we estimate the whole model using the SUR method.
Interpret the results of the OLS regression for α̂1 and α̂2 from an economic and
statistical point of view.
3. Compare the results obtained by estimating each equation separately by OLS with
the results obtained by estimating the whole model using GLS. What do you
conclude ?
4. How would you test the correlation between the residuals of the two equations ?
Describe the test procedure and give the null hypothesis, the test statistic as well
as its distribution.
5. Perform the test described in the previous question using the test value given in
the Stata output. What do you conclude concerning the SUR model based on this
test ?
6. Equations (5) and (6) represent the reduced form of a (simplified) structural model
that describes the influence of institutions on economic development. The structu-
ral form of the model is :
logGDPi = β0 + β1 geographyi + β2 institutionsi + vi1 (7)
institutionsi = η0 + η1 geographyi + η2 smortalityi + vi2 (8)
where the error terms vi1 and vi2 are correlated across equations.
According to the order condition, is equation (7) just-identified, over-identified or
not identified ? Justify your answer.
Econometrics, Fall 2021 3

7. We are particularly interested in obtaining an estimate for β2 . Can we obtain an

estimate for β2 from the reduced form estimates of αk and γk ? If yes, give the
expression for β2 (as a function of αk and γk ).
calculate β̂2 using the results in the Stata output.
[For convenience, we reproduce the structural form of the model here :

logGDPi = β0 + β1 geographyi + β2 institutionsi + vi1 (7)

institutionsi = η0 + η1 geographyi + η2 smortalityi + vi2 (8)

where the error terms vi1 and vi2 are correlated across equations.]
8. Alternatively, can equation (7) be estimated directly ? Which estimation method
is appropriate in order to obtain a consistent estimate of β2 ?
[For convenience, we reproduce the structural form of the model here :

logGDPi = β0 + β1 geographyi + β2 institutionsi + vi1 (7)

institutionsi = η0 + η1 geographyi + η2 smortalityi + vi2 (8)

where the error terms vi1 and vi2 are correlated across equations.]
Econometrics, Fall 2021 4