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The LRM - An Overview
The LRM - An Overview
Damodar Gujarati
Econometrics by Example, second edition
THE LINEAR REGRESSION MODEL (LPM)
The general form of the LPM model is:
Yi = B1 + B2X2i + B3X3i + … + BkXki + ui
Damodar Gujarati
Econometrics by Example, second edition
REGRESSION COEFFICIENTS
B1 is the intercept.
B2 to Bk are the slope coefficients.
Collectively, they are the regression coefficients
or regression parameters.
Each slope coefficient measures the (partial) rate
of change in the mean value of Y for a unit change
in the value of a regressor, ceteris paribus.
Damodar Gujarati
Econometrics by Example, second edition
SAMPLE REGRESSION FUNCTION
The sample counterpart is:
Yi = b1 + b2X2i + b3X3i + … + bkXki + ei
Or, as written in short form:
Yi = bX + ei
where e is a residual.
The deterministic component is written as:
Yi b1 b2 X 2i b3 X 3i ... bk X ki bX
Damodar Gujarati
Econometrics by Example, second edition
THE NATURE OF THE Y VARIABLE
Ratio Scale:
Ratio of two variables, distance between two variables, and
ordering of variables are meaningful.
Interval Scale:
Distance and ordering between two variables meaningful, but
not ratio.
Ordinal Scale:
Ordering of two variables meaningful (not ratio or distance).
Nominal Scale:
Categorical or dummy variables, qualitative in nature.
Damodar Gujarati
Econometrics by Example, second edition
THE NATURE OF DATA
Damodar Gujarati
Econometrics by Example, second edition
THE NATURE OF DATA
Cross-Section Data
Data on one or more variables collected at the same
point in time.
Examples are the census of population conducted by
the Census Bureau every 10 years, opinion polls
conducted by various polling organizations, and
temperature at a given time in several places.
Damodar Gujarati
Econometrics by Example, second edition
THE NATURE OF DATA
Damodar Gujarati
Econometrics by Example, second edition
METHOD OF ORDINARY LEAST SQUARES
i i 1 2 2 i 3 3i
u 2
(Y B B X B X .... Bk X ki ) 2
Damodar Gujarati
Econometrics by Example, second edition
CLASSICAL LINEAR REGRESSION MODEL
Assumptions of the Classical Linear
Regression Model (CLRM):
Damodar Gujarati
Econometrics by Example, second edition
CLASSICAL LINEAR REGRESSION MODEL
Assumptions of the Classical Linear Regression Model
(CLRM):
Damodar Gujarati
Econometrics by Example, second edition
GAUSS-MARKOV THEOREM
On the basis of assumptions A-1 to A-7, the OLS method
gives best linear unbiased estimators (BLUE):
(1) Estimators are linear functions of the dependent
variable Y.
(2) The estimators are unbiased; in repeated applications
of the method, the estimators approach their true values.
(3) In the class of linear estimators, OLS estimators have
minimum variance; i.e., they are efficient, or the “best”
estimators.
Damodar Gujarati
Econometrics by Example, second edition
HYPOTHESIS TESTING: t TEST
To test the following hypothesis:
H0: Bk = 0
H1: Bk ≠ 0
we calculate the following and use the t table to obtain the
critical t value with n-k degrees of freedom for a given level of
significance (or α, equal to 10%, 5%, or 1%):
bk
t
se(bk )
If this value is greater than the critical t value, we can reject H0.
Damodar Gujarati
Econometrics by Example, second edition
HYPOTHESIS TESTING: t TEST
An alternative method is seeing whether zero lies within the
confidence interval:
[bk t / 2 se(bk )] (1 )
If zero lies in this interval, we cannot reject H0.
Damodar Gujarati
Econometrics by Example, second edition
GOODNESS OF FIT, R2
R2, the coefficient of determination, is an overall measure of
goodness of fit of the estimated regression line.
Gives the percentage of the total variation in the dependent
variable that is explained by the regressors.
It is a value between 0 (no fit) and 1 (perfect fit).
Let: Explained Sum of Squares (ESS) (Yˆ Y ) 2
Residual Sum of Squares (RSS) e 2
Total Sum of Squares (TSS) (Y Y ) 2
Damodar Gujarati
Econometrics by Example, second edition