Week 4: Confidence Interval Hypothesis Testing

4.
Week 4
Confidence Interval
&
Hypothesis Testing
Gujarati(2003): Chapter 5
All rights reserved by Dr.Bill Wan Sing Hung - HKBU

How reliable is this OLS estimation? 4.2
(Computing Tutorial #2: Application of Phillips Curve Theory for the Case of Hong Kong)

Properties of OLS estimators–two variable case
4.3
̂1 ̂2 ̂ 2
1. Unbiased ˆ ˆ

efficiency
2. Min. Variance Se ˆ      x 
2
 2
n x
1 2
[Se(ˆ   2ˆ  

2
2
x 2
3. Consistency: as n gets larger, estimator

is more accurate
4.4
Properties of OLS estimators (continue)
ˆ and ˆ are normal distribution
4 & 5.  1 2
6. ˆ ~ N 1 , 2ˆ 
1 1
ˆ ~ N 2 , 2ˆ 
2 2
 n  2  ˆ 2 x 2
~ (n  2 )
 2

Hypothesis Testing and Confidence Interval 4.5
How reliable is the OLS estimation ?
How “close” is ^
 to  ?
How “close” is ^
 to  ?
f ̂2  Estimated ^

falls in area
Density
true
̂2
̂2   2 ̂2  
Random interval (confidence interval)
Hypothesis Testing and Confidence Interval4.6
̂ is called lower confidence bound
ˆ
 is called upper confidence bound
ˆ ˆ
the interval between ( and ( is
called random interval (confidence interval)
0.99
Pr( ˆ 2- < 2 < ˆ 2+ ) = (1-) 0.95
0.90
which (1-) is confidence coefficient:
(0<  <1)
0.01
 is also called the level of significance. 0.05
0.10
4.7
Constructing Confidence Interval for i
By assumptions:
u i ~ N O, u 
 2  Var(u) =

E() = O
ˆ ~ N 1 ,2ˆ  2
xi

2
  ˆ 
2
1 1
n x i2 1
ˆ ~ N 2 ,ˆ2    2
  ˆ 2
2 2 2
xi 2

4.8
Constructing Confidence Interval for i (cont.)
f ̂2 
Actual estimated 2
could be fallen into
these regions
̂2
E̂2  2
4.9
Constructing Confidence Interval for i (cont.)
f  Z Transform into normal

standard distribution
ˆ 2  2
Z
Se ˆ  
O
4.10
(cont.)
Use the normal distribution to make
probabilistic statements about 2 provided the
true 2 is known
ˆ 2   2
Z 
Se ˆ 2 
~ N 0 ,1 
2
 
ˆ   x
2 2
 In practice this is unobserved

Constructing Confidence Interval for i 4.11
(cont.)
For example:
Accept
region
95%
2.5%
2.5%
 1.96 0 1.96

(cont.)
Pr   1 . 96  Z  1 . 96   0 . 95
ˆ 2  2
 Pr  1 . 96   1 . 96  0 . 95
Se (ˆ 2 )
95% confidence interval:
ˆ 2  2
 1 . 96   1 . 96
Se (ˆ 2 )

(cont.)
 ˆ 2  1.96 Seˆ 2  2  ˆ 2  1.96 * Seˆ 2 

 ˆ 2  1.96 Seˆ 2
In practice,  2
is unknown, we have to use the
unbiased estimator
 2
ˆ 2  û i RSS
n2
Instead of using normal standard
distribution,
t-distribution is used.
(cont.)
ˆ 2 2 Or some specific value(s)

t that want to compare
Se (ˆ 2 )
estimated - true parameter
t
standard error of estimator
ˆ 2  2   x2
t
ˆ SEE
Use the t to construct a confidence interval for 2
(cont.)
ˆ 2  2
t   2 a specified value
Seˆ 2 
^2

where Se ˆ 2  
x 2
estimator  true parameter
t
s tan dard error of estimator
ˆ2 2  x 2
t
ˆ
(cont.) 4.16
Use the tc to construct a confidence interval for 2 as
Pr  t , n2 t t, n2  1  

c
 * c
2 2
c
where  t is critical t value at two-tailed
, n2
 2
2
level of significance.  is level of significance
and (n-2) is degree of freedom (in 2-variable case).
(cont.)
Therefore
 c ˆ 2   2

Pr   t 0 .05 , n  2 
c
 t 0 .05 , n  2  0 .90
 Se  ˆ
 2

Pr( -tc0.025, n-2  (2^- 2)/Se(^
2)  t 0.025, n-2 ) = 0.95
c
Rearranging,

Pr ˆ 2 t 0.05 , n  2 * Se ˆ 2   2  ˆ 2  t 0.05 , n  2  Se  ˆ 2
c c

 0 .90
4.18
Then 90% confidence interval for 2 is:
ˆ 2  t 0.05 , n  2  Se ˆ 2
c
̂2 & Se ̂2

c
t 0.05 , n  2 Check it from t-table
Check it from
estimated result
The 95% confidence interval interval for 

becomes
Seˆ 2
c
̂2  t *
0.025, n-2

The t-statistic in computer (EVIEWS) output4.19
Example: Gujarati (2003)pp.123
H0: 2= 0
H1: 2 0
0.5091 - 0
=
0.0357
Se(β^2)
SEE= 
^ RSS
4.20
Example: Gujarati (2003)pp.123
Given ˆ = 0.5091, n = 10, Se(ˆ = 0.0357,
95% confidence interval is:
ˆ  t c  Se( ˆ 2 )
2 , 
2 n 2
c
 0 .5091  t 0 .025 , 8 ( 0 .0357 )
 0 .5091  0 .0823 
 ( 0 .4268 , 0 .5914 )

90% confidence interval is: 4.21
 c
0 .5091 t 0.05 ,8 ( 0 .0357 )
 0.5091  1.860(0.0357)
 0.5091  0.0664 
 (0.4427, 0.5755)

Test-Significance Approach: 4.22
One-tailed T-test decision rule
Step 1: H 0 : ˆ 2  2 H 0 : ˆ 2  2  State the
H1 : ˆ 2  2 H1 : ˆ 2  2  hypothesis
Step 2: ˆ 2  2
t* 
Se ˆ 2
Computed value
c
Step 3: check t-table for t
, n2
look for critical t value

Step 4: compare tc and t*
4.23
One-tailed t-test decision rule
Decision Rule
Step 5: If t > tc ==> reject H0 Right-tail
If t < tc ==> not reject H0
Right-tail left-tail
0 tc < t t < -tc 0
(If t < - tc ==> reject H0 )

Left-tail
(If t > - t c
==> not reject H0 )
4.24
Two-Tailed T-test
1. H 0: ˆ 2 2 State the hypothesis

H 1 :ˆ 2 2
ˆ 2 2
2. Compute t
Se ˆ 2 
c
t
3. Check t-table for critical t value: , n 2
2

4.25
Two-Tailed t-test (cont.)
c
4. Compare t and t
Decision Rule:
5. If t > tc or -t < - tc , then reject Ho
or | t | > | tc |
Accept
region
reject H0 region reject H0 region
 Se ˆ 2  Se ˆ 2 
c
ˆ 2  t c 2 ˆ 2  t  
2, n2 
2, n 2

4.26
One-Tailed t-test
We also could postulate that:

ˆ  0 .3
H0 :  2
H1 : ˆ 2  0.3
1. Compute:
ˆ 2  2
t
Se 
ˆ2 
0 . 5091  0 . 3 0 . 2091
t   5.857
0 . 0357 0 . 0357
4.27
One-Tailed t-test (cont.)
2. Check t-table for t c0.05, 8

where t c0.05, 8 =1.860  = 0.05
3. Compare t and the critical t

t  5 . 857  t0c. 05 , 8  1 . 860
 reject H0

4.28
One-Tailed t-test (cont.)
H 0 : 2  2
ˆ *
“ Decision rule for left-tail test”
ˆ
H1 : 2  2
*
If t < - tc df => reject H0
left-tail
*
^

^ tc• Se()
*- ^
4.29
Two-Tailed t-test
Suppose we postulate that
H 0 :ˆ 2  0.3
H1 : ˆ 2  0.3
Is the observed ̂ compatible with true  2 ?
2
(1) From Confidence-interval approach:

95% confidence-interval is (0.4268, 0.5914)
which does not contain the true 2.
The estimated 2 is not equal to 0.3
4.30
(2) From Significance test approach:
Compare t-value and the critical t-value:
ˆ 2   2 0 .5091  0 . 3 0 .2091
t    5.857
Se  ˆ 2  0 .0357 0 .0357
tc0.025, 8 = 2.306
,
t 5.857  t 0.025, 8  2.306

c
==> reject H0
It means the estimated 2 is not equal 0.3

4.31
“Accepting” or “Rejecting”
"Accept "the null hypothesis:

All we are saying is that on the basis of the
sample evidence we have no reason to reject it; We
are not saying that the null hypothesis is true
beyond any doubt.
Therefore, in “accepting” a Ho , we should
always be aware that another null hypothesis
may be equally compatible with the data.
So, the conclusion of a statistical test is
“do not reject” rather than “accept”.

Week 4: Confidence Interval Hypothesis Testing

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4.

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

1. Unbiased ˆ ˆ

[Se(ˆ   2ˆ  

3. Consistency: as n gets larger, estimator

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

f ̂2  Estimated ^

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

f  Z Transform into normal

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

 ˆ 2  1.96 Seˆ 2  2  ˆ 2  1.96 * Seˆ 2 

ˆ 2 2 Or some specific value(s)

Use the tc to construct a confidence interval for 2 as

Pr  t , n2 t t, n2  1  

̂2 & Se ̂2

The 95% confidence interval interval for 

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

look for critical t value

0 tc < t t < -tc 0

(If t < - tc ==> reject H0 )

1. H 0: ˆ 2 2 State the hypothesis

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

reject H0 region reject H0 region

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

We also could postulate that:

2. Check t-table for t c0.05, 8

3. Compare t and the critical t

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

(1) From Confidence-interval approach:

t 5.857  t 0.025, 8  2.306

All rights reserved by Dr.Bill Wan Sing Hung - HKBU

"Accept "the null hypothesis:

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