EC3304 Econometrics II Semester 1, 2013-2014 Midterm Exam October 1, 2013

MATRICULATION/REGISTRATION NUMBER: TUTORIAL GROUP:

Instructions 1. Do NOT start reading the questions until you are told to do so. 2. This exam will last 90 minutes. 3. There are a total of 6 pages, including this front page. 4. This exam consists of EIGHT (8) questions. Answer ALL EIGHT questions. You must include your work in order to receive full marks. 5. The exam totals 100 points.

Questions 1 to 5 are multiple-choice questions. Write your answer to each question in the answer book. 1. (5 points) Consider the regression example from your textbook, which estimates the eect of beer taxes on vehicle fatality rates across 48 U.S. states. If beer taxes were set nationally by the federal government rather than by the states, then (a) the OLS estimator will be biased. (b) it would not make sense to use state xed eects. (c) you can test for state xed eects using homoskedastic-only standard errors. (d) you should not use time xed eects since beer taxes are the same across states for a given period. 2. (5 points) Time xed eects are useful in dealing with omitted variables (a) if these omitted variables are constant across entities but vary over time. (b) when there are more than 100 observations. (c) even if you only have a cross-section of data available. (d) if these omitted variables vary across entities but not over time. 3. (5 points) The major aw of the linear probability model is that (a) values of the dependent variable can only be 0 and 1 but predicted values are almost never 0 and 1. (b) people do not always make clear-cut decisions. (c) the regression R2 cannot be used as a measure of t. (d) predicted values can lie above 1 and below 0. 4. (5 points) The following problems could be analyzed using probit and logit estimation with the exception of whether or not (a) a student will attend a certain university after being accepted. (b) a student decides to study abroad for one semester. (c) being a female has an eect on earnings. (d) applicants will default on a loan.

5. (5 points) In the case of the simple regression model Yi = 0 +1 Xi +ui , i = 1, . . . , n, when X and u are correlated: (a) the OLS estimator is inconsistent. (b) the OLS estimator is biased in small samples only. (c) OLS and TSLS produce the same estimate. (d) X is exogenous. For questions 6 to 8, write your answers and any work necessary to derive your answers in the answer book. 6. (20 points total) Consider a linear probability model that captures the eect of homeownership on volunteerism: volunteeri = 0 + 1 owni + ui , where volunteeri is a binary variable indicating whether individual i volunteers in a community organization and owni is a binary variable indicating whether individual i owns a home. Note that all the usual assumptions and results of instrumental variables regression apply to the linear probability model. (a) (5 points) Why might own be correlated with u? (b) (5 points) Do you think income would be a good IV for own? Why or why not? (c) (10 points) Suppose that the government randomly distributes housing subsidies to new households. Carefully explain how you would use this information to construct an instrumental variable for own. Be specic. 7. (25 points total) The logarithm of the likelihood function for a random sample of n observations of random variable Y N (, 2 ) is as follows: n n 1 L = ln (2 ) ln 2 2 2 2 2
n

(yi )2
i=1

(a) (15 points) Derive the maximum likelihood estimator for the mean, M LE , and
2 the variance, M LE .

(b) (10 points) Show whether the MLE estimators that you derived in part (a) are consistent.
3

8. (30 points total) A researcher investigating the determinants of crime in the United Kingdom has data for 42 regions over 22 years. She estimates the following regression by OLS: ln (cmrtit ) = i +t +1 unrtmit +2 proythit +3 ln (pp)it +uit , i = 1, . . . , 42, t = 1, . . . , 22 where cmrt is the crime rate per head of population, unrtm is the unemployment rate of males, proyth is the proportion of youths, and pp is the probability of punishment measured as (number of convictions)/(number of crimes reported). i and t are region and year xed eects. 1 is not included. (a) (10 points) What is the purpose of excluding 1 ? What eects are i and t likely to pick up? (b) (10 points) Estimation by OLS using heteroskedasticity and autocorrelationconsistent standard errors results in the following output (the coecients of the xed eects are not reported): ln (cmrtit ) = 0.063 unrtmit + 3.739 proythit 0.588 ln (ppit ) (0.109) (0.179) (0.024)

Comment on the results. What is the eect of a 1% increase in the probability of punishment? (c) (10 points) You run an F-test to test the signicance of the time xed eects. The relevant F -statistic is 1.7. What are the degrees of freedom? What is the critical value from the F table on page 5? (You may have to approximate the critical value if the degrees of freedom are not listed in the table.) What do you conclude?

Critical Values of the Fm, Distribution

Significance Level Degrees of Freedom 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 25 30 35 40 45 50 100 10% 2.71 2.31 2.09 1.95 1.85 1.78 1.72 1.68 1.64 1.61 1.58 1.55 1.53 1.51 1.49 1.48 1.46 1.45 1.44 1.43 1.38 1.35 1.32 1.30 1.29 1.27 1.20 5% 3.85 3.00 2.61 2.38 2.22 2.11 2.02 1.95 1.89 1.84 1.80 1.76 1.73 1.70 1.68 1.65 1.63 1.61 1.60 1.58 1.52 1.47 1.43 1.41 1.38 1.36 1.26 1% 6.66 4.63 3.80 3.34 3.04 2.82 2.66 2.53 2.43 2.34 2.27 2.20 2.15 2.10 2.06 2.02 1.98 1.95 1.92 1.90 1.79 1.72 1.66 1.61 1.58 1.54 1.38

Formulas Note If ln (y ) = 0 + 1 X + u, then 1 100 is the expected (approximate) percentage change in Y for a 1 unit increase in X . That is, if 1 = 0.02, then a 1 unit increase in X is expected to increase Y by 2%. Theorems Law of Large Numbers: If Yi , i = 1, . . . , n are i.i.d with E (Yi ) = Y and var (Yi ) < , then Y y Central Limit Theorem:
2 2 If Y1 , . . . , Yn are i.i.d. with E (Yi ) = Y and var (Yi ) = Y , where 0 < Y < , then, for large n, a 2 n Y Y N 0, Y p

Fixed eects
n T

it Y it X 1 =
i=1 t=1 n T

, 2 X it

a 1 N

1 ,

2 nQ4 X

Q2 = E X
t=1

2 it X

i=1 t=1

Case 1. Uncorrelated errors:

2

1 = n1

2u 2 X it it
i=1 t=1

Case 2. Correlated errors:

2 ,clustered

1 = n1

it u X it
i=1 t=1

Instrumental Variables T SLS = sY Z , 1 sXZ

a 2 T SLS N 1 , T SLS , 1
1

2 T SLS =
1

1 var ((Z z ) u) n cov (Z, X )2