Financial Econometrics Project Part 1

Name: Muhammad Maaz Ahmed Siddiqui

Reg# 2020323
Date: 18/10/22
Introduction:
The chosen model is used to examine how area (square footage), the number of bathrooms,
and the number of bedrooms affect apartment prices in (thousands of dollars). Although there
are many more elements that might affect the price of an apartment in the real world, in our
model we have only concentrated on the three that we have chosen.
It is obvious that the more square feet an apartment has, the more expensive it will be. The
same logic holds true for the other two factors.
The model's main goal is to determine how big of an impact an increase of one unit in the
independent variable has on the dependent variable.

Econometric model:

The purpose of the study is to ascertain how specific factors, such as square footage, the
number of bathrooms, and the number of bedrooms, affect the pricing (in thousands of
dollars). The econometric model below was created with this goal in mind.

Yi = α + β1 X1 + β2 X2 + β3 X3 + εi
salepric= α + β1sqft + β2bedrms + β3baths

Here:
salepric: It is the dependent variable measured in thousands of dollars.
α: The intercept term alpha is to estimate the value of sale price at x=0
β1: It is the coefficient of regression for the area in (sq ft) used to measure the change in sale
price due to 1 unit increase in sqft holding the other variables constant.
Sqft: It is the independent variable 1, square feet are the method to measure the area of the
apartment.
β2: It is the coefficient of regression for number of bedrooms in the apartment, it is used to
measure the change in sale price due to 1 unit change or increase in bedrms holding the other
variables constant.
Bedrms: it is the independent variable 2, number of bedrooms in the apartment which is
measured in numbers.
β3: It is the coefficient of regression for the number of bathrooms in the apartment, it is used
to measure the change in sale price due to increase in numbers by 1 unit change.
baths: It is the independent variable 3, number of bathrooms in the apartment which is
measured in numbers.
εi: The stochastic error term denoting all other factors that can affect the sale price aside from
the three independent variables in our model.

Interpretation of results:
To determine if the relationship between each of the model's variables and the answers is
statistically significant. First, we start with the p-value to assess the null hypothesis. in the
selected model the variable square feet is statistically significant because the p-value is less
than the significance level i.e. (0.05). Let’s move toward the fitment and significance of our
model.
R-square explains how much variation of a dependent variable is being explained by the
independent variables. The R-square is the percentage of the variation in the variables of the
selected model. in our model the R-square is 83% which is a high value, the higher the value of
the R-square indicates and justifies the model fits our data. Now move towards the adjusted R-
square which is a modified version of the R-square, the adjusted R-square is significant, and it
would only increase when there is some sort of real improvement. in our model, the value of
the adjusted R-square is 78.07% which shows that there is 78% variation in the variables and
the model is significant.
Running regression analysis:

Using the OLS technique to run regression analysis on the econometric model.
Estimated Equation:

The study was conducted to determine the effects of three independent variables named area
in sq ft, number of bedrooms and number of bathrooms on the sale price of an apartment. For
this reason, macroeconomic data was obtained from Gretl software and analyzed through
regression by using the OLS model. After analysis the following equation is generated.

Yi = α + β1 X1 + β2 X2 + β3 X3 + εi
salepric= 129.062 + 0.154800 sqft + (-21.5875bedrms) + (-12.1928baths)

Test for Multicollinearity:

The word "multicollinearity" describes a situation in which a model's independent variables are
correlated. Regression analysis seeks to establish the link between each independent variable
and dependent variable; hence this is a difficulty. As a result, while calculating regression
coefficients for a certain variable, all other variables are kept constant. However, if the
independent variables are more closely connected, they may have an impact on one another
and result in estimates that are not the Best Linear Unbiased Estimator (BLUE). Regression
cannot fulfil its objective due to multicollinearity, which also violates one of the traditional
tenets of the OLS model.
“No independent variable is a perfect linear function of another explanatory variable, according
to the statement.”. A formal test for multicollinearity in a model is the Variance.
The VIF index for each of the variable is then calculated using the unadjusted R-square value for
each equation

VIF(β^1) = 1 / (1 – R Square)
The VIF index value is then judged to determine the level of multicollinearity. A VIF index value
calculated from R-square=1 indicates perfect multicollinearity while VIF value=1, calculated
from R-square=0 indicates no multicollinearity. Values between 1-5 or 1-10 in some cases
indicates moderate level of multicollinearity while the VIF which is >5 or >10 in case of Gretl
software indicates critical levels of multicollinearity.
The above figure highlights the results obtained when the VIF test is applied on the
independent variables of this model to test multicollinearity. The (sqft) has a VIF index of 2.651,
(bedrms) has a VIF index of 1.406 while (baths) has a VIF index of 2.900.
According to Gretl software multicollinearity is considered critical when VIF>10.00. Therefore,
there is no issue of multicollinearity in our model.

Conclusion:
Regression analysis using the OLS model was done on data taken from the Gretl sample file on
house prices and square feet in order to assess the impact of three independent variables on
the sale price of an apartment. The proposed econometric model's effectiveness was assessed
using the Coefficient of Determination, and the computed regression coefficients' statistical
significance and multicollinearity were examined, as well as their consistency with predicted
outcomes. It was discovered that the square footage in square feet, the number of bedrooms,
and the number of bathrooms all had a positive and substantial association with the sale price.