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405 Econometrics: by Domodar N. Gujarati
405 Econometrics: by Domodar N. Gujarati
Prof. M. El-Sakka
Dept of Economics Kuwait University
THE METHOD OF ORDINARY LEAST SQUARES
II. They are point estimators; that is, given the sample, each estimator will
provide only a single (point, not interval) value of the relevant population
parameter.
III. Once the OLS estimates are obtained from the sample data, the sample
regression line (Figure 3.1) can be easily obtained.
The least-squares estimates are a function of the sample data. But since the
data change from sample to sample, the estimates will change. Therefore,
what is needed is some measure of reliability or precision of the estimators
1 and 2. In statistics the precision of an estimate is measured by its
standard error (se), which can be obtained as follows:
2 is the constant or homoscedastic variance of ui of Assumption 4.
2 itself is estimated by the following formula:
where 2 is the OLS estimator of the true but unknown 2 and where the
expression n2 is known as the number of degrees of freedom (df), is the
residual sum of squares (RSS). Once is known, 2 can be easily
computed.
Compared with Eq. (3.1.2), Eq. (3.3.6) is easy to use, for it does not require
computing ui for each observation.
Since
Since var (2) is always positive, as is the variance of any variable, the nature
of the covariance between 1 and 2 depends on the sign of X . If X is
positive, then as the formula shows, the covariance will be negative. Thus, if
the slope coefficient 2 is overestimated (i.e., the slope is too steep), the
intercept coefficient 1 will be underestimated (i.e., the intercept will be too
small).
PROPERTIES OF LEAST-SQUARES ESTIMATORS:
THE GAUSSMARKOV THEOREM
We now consider the goodness of fit of the fitted regression line to a set of
data; that is, we shall find out how well the sample regression line fits the
data. The coefficient of determination r2 (two-variable case) or R2 (multiple
regression) is a summary measure that tells how well the sample regression
line fits the data.
Consider a heuristic explanation of r2 in terms of a graphical device, known
as the Venn diagram shown in Figure 3.9.
In this figure the circle Y represents variation in the dependent variable Y and
the circle X represents variation in the explanatory variable X. The overlap of
the two circles indicates the extent to which the variation in Y is explained by
the variation in X.
To compute this r2, we proceed as follows: Recall that
Yi = Yi +ui (2.6.3)
or in the deviation form
yi = yi + ui (3.5.1)
where use is made of (3.1.13) and (3.1.14). Squaring (3.5.1) on both sides
and summing over the sample, we obtain