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Dougherty

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

© Christopher Dougherty, 2016. All rights reserved.

 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

In practice we deal with finite samples, not infinite ones. So why should we be interested in
whether an estimator is consistent?

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

If no unbiased estimator exists, a consistent estimator may be

preferred to an inconsistent one.

We have already considered this issue in the previous sequence. One reason is that often, in
practice, it is impossible to find an estimator that is unbiased for small samples. If you can find
one that is at least consistent, that may be better than having no estimate at all.
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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

If no unbiased estimator exists, a consistent estimator may be

preferred to an inconsistent one.
It is often not possible to determine the expectation of an
estimator, but still possible to evaluate probability limits.

A second reason is that often we are unable to say anything at all about the expectation of an
estimator. The expected value rules are weak analytical instruments that can be applied in
relatively simple contexts.
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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

If no unbiased estimator exists, a consistent estimator may be

preferred to an inconsistent one.
• If the estimator is consistent, it may have desirable finite
sample properties.
• If the estimator is inconsistent, we know that for finite
samples it will definitely be biased.

We will discuss the first point further here. If we can show that an estimator is consistent,
then we may be optimistic about its finite sample properties, whereas if the estimator is
inconsistent, we know that for finite samples it will definitely be biased.
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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

If no unbiased estimator exists, a consistent estimator may be

preferred to an inconsistent one.
• If the estimator is consistent, it may have desirable finite
sample properties.
• If the estimator is inconsistent, we know that for finite
samples it will definitely be biased.

Reasons for caution

• A consistent estimator may be biased for finite samples.

However, there are reasons for being cautious about preferring consistent estimators to
inconsistent ones. First, a consistent estimator may be biased for finite samples.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

If no unbiased estimator exists, a consistent estimator may be

preferred to an inconsistent one.
• If the estimator is consistent, it may have desirable finite
sample properties.
• If the estimator is inconsistent, we know that for finite
samples it will definitely be biased.

Reasons for caution

• A consistent estimator may be biased for finite samples.
• A consistent estimator may have a larger variance than an
inconsistent one and be inferior using the mean square error
or similar criterion.

Second, we are usually also interested in variances. If a consistent estimator has a larger
variance than an inconsistent one, the latter might be preferable if judged by the mean
square error or similar criterion that allows a trade-off between bias and variance.
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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Why are we interested in consistency?

If no unbiased estimator exists, a consistent estimator may be

preferred to an inconsistent one.
• If the estimator is consistent, it may have desirable finite
sample properties.
• If the estimator is inconsistent, we know that for finite
samples it will definitely be biased.

Reasons for caution

• A consistent estimator may be biased for finite samples.
• A consistent estimator may have a larger variance than an
inconsistent one and be inferior using the mean square error
or similar criterion.
• An inconsistent estimator could even be preferable to an
unbiased one.

(We saw in a previous sequence that a consistent estimator might be preferable to an

unbiased estimator, using this criterion. The same is true of an inconsistent estimator.)

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

These issues cannot be resolved using mathematical analysis

How can you resolve these issues? Mathematically they are intractable, otherwise we
would not have resorted to large sample analysis in the first place.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

These issues cannot be resolved using mathematical analysis

Alternative technique: simulation

The answer is to conduct a simulation experiment, directly investigating the distributions of

estimators under controlled conditions.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

Model: Y  Z Y
Estimator of a :
X  Zw X

 5 Z ~ N  1, 0.25 w ~ N  0, 1

We will do this for the example presented at the end of the previous sequence. We will set
a equal to 5, so the value of Y in any observation is 5 times the value of Z.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

Model: Y  Z Y
Estimator of a :
X  Zw X

 5 Z ~ N  1, 0.25 w ~ N  0, 1

We will generate Z as a random variable with a normal distribution with mean 1 and
variance 0.25.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

Model: Y  Z Y
Estimator of a :
X  Zw X

 5 Z ~ N  1, 0.25 w ~ N  0, 1

We will generate the measurement error w as a normally distributed random variable with
zero mean and unit variance.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

Model: Y  Z Y
Estimator of a :
X  Zw X

 5 Z ~ N  1, 0.25 w ~ N  0, 1

We then use Y/X as an estimator of a.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

Simulation

Model: Y  Z Y
Estimator of a :
X  Zw X

 5 Z ~ N  1, 0.25 w ~ N  0, 1

Y Z

X Zw
plim Z   Z  plim Z   Z
plim w  0  plim  Z  w    Z
Y  Z
plim    assumption:  Z  0
X Z

We have already seen that the estimator is consistent. The question now is how well it
performs in finite samples.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

3 n mean s.d.
probability density function

25 5.217 1.181

n = 25
10 million samples
0
0 1 2 3 4 5 6 7 8 9 10

We will start by taking samples of size 25. The figure shows the distribution of a, the
estimator of a, for 10 million samples.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

3 n mean s.d.
probability density function

25 5.217 1.181

n = 25
10 million samples
0
0 1 2 3 4 5 6 7 8 9 10

Although the mode of the distribution Is lower than the true value, the estimator is upwards
biased, the mean estimate in the 10 million samples being 5.217.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

3 n mean s.d.
probability density function

25 5.217 1.181
100 5.052 0.524
400 5.013 0.253
2

n = 400
1
n = 100
n = 25
10 million samples
0
0 1 2 3 4 5 6 7 8 9 10

If we increase the sample size to 100 and then 400, the distribution of the estimates
obtained with 10 million samples becomes less skewed and the bias diminishes.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

3 n mean s.d.
probability density function

25 5.217 1.181 n = 1,600

100 5.052 0.524
400 5.013 0.253
2 1600 5.003 0.125

n = 400
1
n = 100
n = 25
10 million samples
0
0 1 2 3 4 5 6 7 8 9 10

If we increase the sample size to 1,600, the distribution of the estimates obtained with 10
million samples is hardly skewed at all and the bias has almost vanished. The mean is
5.003.
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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

3 n mean s.d.
probability density function

25 5.217 1.181 n = 1,600

100 5.052 0.524
400 5.013 0.253
2 1600 5.003 0.125

n = 400
1
n = 100
n = 25
10 million samples
0
0 1 2 3 4 5 6 7 8 9 10

We demonstrated analytically that the estimator is consistent, but this is a theoretical

property relating to samples of infinite size.

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 ASYMPTOTIC PROPERTIES OF ESTIMATORS: THE USE OF SIMULATION

3 n mean s.d.
probability density function

25 5.217 1.181 n = 1,600

100 5.052 0.524
400 5.013 0.253
2 1600 5.003 0.125

n = 400
1
n = 100
n = 25
10 million samples
0
0 1 2 3 4 5 6 7 8 9 10

The simulation shows us that for sample size 1,600, the estimator is almost unbiased.
However for smaller sample sizes the estimator is biased, especially when the sample size
is as small as 25.
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Copyright Christopher Dougherty 2016.

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The content of this slideshow comes from Section R.14 of C. Dougherty,

Introduction to Econometrics, fifth edition 2016, Oxford University Press.
Additional (free) resources for both students and instructors may be
downloaded from the OUP Online Resource Centre
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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