Lecture 15.

Dummy variables, continued

Seasonal effects in time series
Consider relation between electricity consumption Y and electricity
price X .
The data are quarterly time series.
First model
ln Yt = 1 + 2 ln X t + ut

What is the interpretation of 2 ?

Because electricity consumption depends on the weather and special

circumstances (Christmas, summer holidays) we expect is to be
different in the quarters, even if the price is constant.
Solution: Define
Dt1 = 1 if t is the first quarter of a year
Dt1 = 0 if not

Define Dt 2 , Dt 3 , Dt 4 analogously for the other quarters.

To allow for differences in the average consumption between

quarters we write
1 = 1 + 2 D2 + 3 D3 + 4 D4

Substitution in the regression model gives

ln Yt = 1 + 2 Dt 2 + 3 Dt 3 + 4 Dt 4 + 2 ln X t + ut

Why not Dt1 in model?

Average electricity consumption in the four quarters (given price X t )

Quarter 1

E (ln Yt | X t ) = 1 + 2 ln X t

Quarter 2

E (ln Yt | X t ) = 1 + 2 + 2 ln X t

Quarter 3

E (ln Yt | X t ) = 1 + 3 + 2 ln X t

Quarter 4

E (ln Yt | X t ) = 1 + 4 + 2 ln X t

Interpretation 2 , 3 , 4 : Relative change (relative to quarter 1) of

electricity consumption in quarters 2,3,4.

Change of reference quarter to quarter 2:

1 = 1 + 2 D1 + 3 D3 + 4 D4

Intercept in the four quarters

Reference quarter is quarter 1
1 , 1 + 2 , 1 + 3 , 1 + 4

Reference quarter is quarter 2

1 + 2 , 1, 1 + 3 , 1 + 4

Hence
1 = 1 + 2 , 2 = 2 , 3 = 3 2 , 4 = 4 2

The same relations hold for the OLS estimates. Change of reference
quarter does not require re-estimation.
Same result holds for change in reference category for any
qualitative variable with more than two values (e.g. earlier example
with type of work)

If we want to investigate whether price elasticity depends on season

we write
2 = 5 + 6 D2 + 7 D3 + 8 D4

Substitution gives
ln Yt = 1 + 2 Dt 2 + 3 Dt 3 + 4 Dt 4 + 5 ln X t +

6 Dt 2 ln X t + 7 Dt 3 ln X t + 8 Dt 4 ln X t + ut

Price elasticities in the four quarters

Quarter 1
Quarter 2
Quarter 3
Quarter 4

5
5 + 6
5 + 7
5 + 8

Tests:
Average demand does not change with the season
Price elasticity constant over seasons
Derive price elasticities if we choose period 2 as reference period.

Structural change
Events may change the relation between economic variables.
Consider time series data on dependent variable Y and
independent variable X for e.g. years t = 1,K, n .
In year t = n0 some event happens.
This event induces a structural change if the regression
coefficients change due to the event.

Original model (no structural change)

Yt = + X t + ut ,

t = 1,K, n

Model with structural change in n0 :

Yt = 1 + 1 X t + ut ,

t = 1, K , n0

Yt = 1 + 2 + ( 1 + 2 ) X t + ut ,

t = n0 + 1,K , n

This is equivalent to introducing the dummy variable

Dt = 0 for t = 1, K, n0
Dt = 1 for t = n0 + 1, K , n

with the model

Yt = 1 + 2 Dt + 1 X t + 2 Dt X t + ut ,

t = 1,K , n

Test for structural change can be done in two ways

Estimate separate models and compare ESS
Estimate model with dummy and test 2 = 0, 2 = 0
This gives the same value for the test statistic.

Outliers
There may be individual observations that do not fit the relation
See output/graphs
Reason:
Omitted variables
Error in the data
Some unknown event/circumstance
How to check this?

Introduce dummy variable

Di , 23 = 1 for observation 23 (and 0 otherwise)

Include this in the regression model and test whether coefficient is 0.

See output.

Dependent Variable: LNWAGE

Method: Least Squares
Date: 11/01/01 Time: 08:42
Sample: 1 49
Included observations: 49
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
EDUC
EXPER
AGE
RACE
GENDER

6.864366
0.052987
0.020776
-0.002250
0.071479
0.242610

0.186127
0.017107
0.006321
0.003804
0.081543
0.071645

36.88002
3.097432
3.286999
-0.591382
0.876575
3.386300

0.0000
0.0034
0.0020
0.5574
0.3856
0.0015

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat

0.470916
0.409395
0.240344
2.483904
3.530733
1.708658

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)

7.454952
0.312741
0.100786
0.332438
7.654508
0.000032

0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
5

10

15

20

25

30

35

LNWAGE Residuals

40

45

obs

Actual

Fitted

Residual

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49

7.20415
7.79770
7.44717
7.28688
7.40184
7.20415
7.37901
7.04229
7.35628
7.31055
7.11802
7.20415
7.20415
8.12829
7.51698
6.88857
7.20415
7.35628
7.07918
7.20415
7.20415
7.68110
7.24566
7.65681
7.70436
8.18172
7.58680
7.11802
7.56320
7.68018
7.76853
7.20415
7.51698
7.86825
7.83716
7.37901
7.51698
7.70436
7.33237
7.28688
8.10380
8.25140
7.51698
7.28688
7.26753
7.65681
7.51698
7.16085
7.16085

7.20983
7.64738
7.47824
7.44899
7.57869
7.27025
7.36391
7.06440
7.78801
7.61880
7.16206
7.19236
7.36341
7.90676
7.67094
7.34406
7.54399
7.14941
7.21830
7.41777
7.35979
7.56638
7.69937
7.51358
7.68690
7.69434
7.32344
7.09935
7.43966
7.43267
7.35286
7.41537
7.28394
7.65101
7.72690
7.39163
7.69670
7.45990
7.18733
7.29798
8.01117
7.75389
7.48605
7.29015
7.58319
7.35894
7.51702
7.37542
7.20015

-0.00568
0.15032
-0.03107
-0.16212
-0.17685
-0.06610
0.01509
-0.02211
-0.43173
-0.30825
-0.04404
0.01179
-0.15926
0.22153
-0.15396
-0.45549
-0.33984
0.20687
-0.13911
-0.21362
-0.15564
0.11472
-0.45372
0.14323
0.01746
0.48738
0.26337
0.01866
0.12354
0.24751
0.41568
-0.21122
0.23304
0.21724
0.11026
-0.01262
-0.17973
0.24446
0.14504
-0.01110
0.09263
0.49751
0.03093
-0.00328
-0.31567
0.29787
-4.2E-05
-0.21458
-0.03930

Residual Plot

Dependent Variable: LNWAGE

Method: Least Squares
Date: 10/29/01 Time: 22:21
Sample: 1 49
Included observations: 49
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
GENDER
AGE
EXPER
EDUC
RACE
D23

6.789626
0.261107
-0.001271
0.018787
0.061945
0.065118
-0.530696

0.182398
0.069438
0.003687
0.006149
0.016981
0.078464
0.249938

37.22432
3.760286
-0.344724
3.055107
3.647842
0.829904
-2.123314

0.0000
0.0005
0.7320
0.0039
0.0007
0.4113
0.0397

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat

0.522205
0.453948
0.231101
2.243118
6.028867
1.653329

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)

7.454952
0.312741
0.039638
0.309898
7.650623
0.000014

Dependent Variable: LNWAGE

Method: Least Squares
Date: 11/01/01 Time: 08:47
Sample: 1 49
Included observations: 49
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
GENDER
EXPER
EDUC
AGE
RACE
D23
CLERICAL
CRAFTS
MAINT

7.401588
0.276639
0.017241
0.022429
-0.002105
0.095861
-0.293381
-0.419411
-0.342397
-0.525459

0.160656
0.074299
0.004698
0.013386
0.002676
0.060972
0.187884
0.083845
0.081728
0.092669

46.07096
3.723311
3.669938
1.675632
-0.786674
1.572208
-1.561503
-5.002245
-4.189469
-5.670253

0.0000
0.0006
0.0007
0.1018
0.4362
0.1240
0.1265
0.0000
0.0002
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat

0.778514
0.727402
0.163285
1.039816
24.86503
1.985725

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)

7.454952
0.312741
-0.606736
-0.220650
15.23148
0.000000

Application: Election 2000 in Florida

Effect of butterfly ballot in Palm Beach County on Buchanan vote
Data for all Florida counties
Votes candidates
Size and demographic composition of counties (census). What is
relevant?

Model
Dependent variable?
Independent variables?
How do we check whether Palm Beach is different?

Election 2000 in Florida: Butterfly ballot in Palm Beach county

Outcome of 2000 presidential election disputed.
Claims of voting irregularities in Florida.
One issue was a confusing ballot design in Palm Beach county, the
butterfly ballot.
Order of punch holes different from order of the two main candidates,
Bush and Gore.
Claim: Many voters mistakenly voted for Buchanan, the candidate of
the Reform Party.

Research question: Did Buchanan get an unusually large fraction of the

votes in Palm Beach county?

Regression model
Dependent variable: log of fraction votes for Buchanan.
Independent variables
Percentage of population Hispanic
Percentage of population Black
Percentage of population over 65
Percentage of population with college degree
Income (1000$ per year)
Population (10000)

Descriptive statistics

Date:
04/06/05
Sample: 1 67

Time: 22:14

FRACBUCHA

FRACGORE

FRACBUSH

PERCBLACK PERCHISPAN PERCOVER6 PERCCOLLE INCOME1000 POPULATION

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis

0.004697
0.003976
0.017452
0.000897
0.003218
1.912928
7.448237

0.428125
0.430705
0.676075
0.241105
0.091383
0.348309
3.331569

0.551544
0.549881
0.741084
0.310129
0.092058
-0.282254
3.187830

15.89701
14.40000
61.80000
2.300000
11.07191
1.926733
7.627821

6.288060
3.500000
54.40000
0.900000
8.186436
3.699223
19.94750

16.80293
14.60939
33.43856
6.974674
7.011421
0.846034
2.718083

13.89701
11.90000
37.10000
5.200000
6.588534
1.203425
4.690722

26.18864
25.71800
38.13000
17.09800
4.794646
0.446578
2.364601

21.87156
8.191900
204.4600
0.628900
36.05383
3.023152
13.30769

Jarque-Bera
Probability

96.10031
0.000000

1.661643
0.435691

0.988110
0.610147

101.2424
0.000000

954.6232
0.000000

8.214687
0.016451

24.15201
0.000006

3.354070
0.186927

398.6674
0.000000

Observations

67

67

67

67

67

67

67

67

67

OLS results: Basis equation

 Signs of coefficients plausible?

Interpretation of coefficients: dependent variable is log!

OLS residuals: Graph

2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
5 10 15 20 25 30 35 40 45 50 55 60 65
LNFRACBUCHANAN Residuals

OLS residuals: Table

OLS results: Palm Beach dummy

To check whether Palm Beach is special include dummy that is 1 for Palm
Beach (observation 50) and 0 otherwise

Interpretation of Palm Beach dummy

ln y = 2.521 + " + 1.794d

Hence

ln yobserved ln y normal = 1.794

so that

yobserved y normal
= e1.794 1 = 5.103
y normal
i.e. fraction 5 times higher than expected. Fraction is .00789.

Sensitivity check: Include log fraction Bush vote

Effect on Bush and Gore vote