Type author name/s here

Dougherty

Introduction to Econometrics,
5th edition
Chapter heading
Review: Random Variables,
Sampling, Estimation, and
Inference

© Christopher Dougherty, 2016. All rights reserved.

 THE FIXED AND RANDOM COMPONENTS OF A RANDOM VARIABLE

Population mean of X: E Xi   X

In this short sequence we shall decompose a random variable X into its fixed and random
components. Let the population mean of X be mX.

1
 THE FIXED AND RANDOM COMPONENTS OF A RANDOM VARIABLE

Population mean of X: E Xi   X

Random component In observation i: ui  X i   X

The actual value of X in any observation will in general be different from mX. We will call the
difference ui, so ui = Xi – mX.

2
 THE FIXED AND RANDOM COMPONENTS OF A RANDOM VARIABLE

Population
Populationmean
mean X:X:
ofof E Xi   X

In observation
Random i, theInrandom
component observation i: ui  X i   X
component is given by

Decomposition
Hence Xi can ofbeX i:
decomposed X i   X  ui
into fixed and random components:

Re-arranging this equation, we can decompose Xi as the sum of its fixed component, mX,
which is the same for all observations, and its random component, ui.

3
 THE FIXED AND RANDOM COMPONENTS OF A RANDOM VARIABLE

Population mean of X: E Xi   X

Random component In observation i: ui  X i   X

Decomposition of Xi : X i   X  ui

Expected value of ui is zero: E  ui   E  X i   X 

 E X i   E  X 
 X  X  0

The expected value of the random component is zero. It does not systematically tend to
increase or decrease X. It just makes it deviate from its population mean.

4
 THE FIXED AND RANDOM COMPONENTS OF A RANDOM VARIABLE

Population mean of X: E Xi   X

Random component In observation i: ui  X i   X

Decomposition of Xi : X i   X  ui

Variance of X is same as variance of u: 

 X2  E  X i   X 
2

 E  u2 


 u2  E  ui  0 
2

 E  u2 

The variance of X is equal to the variance of u. This is obvious, since all the variation in X
is caused by the variation in u.

5
Copyright Christopher Dougherty 2016.

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Introduction to Econometrics, fifth edition 2016, Oxford University Press.
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Individuals studying econometrics on their own who feel that they might benefit
from participation in a formal course should consider the London School of
Economics summer school course
EC212 Introduction to Econometrics
http://www2.lse.ac.uk/study/summerSchools/summerSchool/Home.aspx
or the University of London International Programmes distance learning course
EC2020 Elements of Econometrics
www.londoninternational.ac.uk/lse.

2015.12.17