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Econometric Methods (U20451) Assignment


Phase 1
X
450,000
400,000
350,000
300,000
250,000
200,000
150,000
1980

1985

1990

1995

2000

2005

2010

2015

2000

2005

2010

2015

Y
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
1980

1985

1990

1995

Both X (UK GDP) and Y (UK Imports) have a positive linear relationship over time, with
expected anomalies due to economic events. Both immediately see a decline, GDP falls
3.45% between 1980 and 1981 and Imports fell 17.4% in the same period. This was due to
the early 1980s recession, with GDP not reaching its 1980 level until the fourth quarter 1982.
Both variables generally continue with a steady increase, until the UK economy was affected
by another global recession in 1990. Variable X decreased for 5 straight quarters (1990 Q2-

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1991 Q3) whilst Y was decreasing for 4 (1990-Q1-1991-Q1). For a long period of time
following this, a steady incline of both X and Y against time took place. A significant rise of
UK imports occurred in 2005, which wasnt as noticeable in the UK GDP graph. However
the global financial crisis of 2008 is very visible on both graphs, in which the greatest period
of fall in X and Y is recorded. Upon recovery from the recession, both graphs display a
general return to the steady increase in values up to the present day.

Phase 2
If the expected disturbance is zero, then Yt will equal to the result of the constant, B0, plus a
value of B1 for each additional unit of Xt. Thus, starting with B0, for every additional 1 of Xt,
you can expect Yt to increase by B1.
Dependent Variable: Y
Method: Least Squares
Date: 04/19/16 Time: 16:46
Sample: 1980Q1 2015Q1
Included observations: 141
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
X

-80086.58
0.519456

1605.405
0.004993

-49.88558
104.0330

0.0000
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.987320
0.987228
4409.363
2.70E+09
-1382.263
10822.88
0.000000

Mean dependent var


S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

82399.46
39017.04
19.63493
19.67676
19.65193
0.274235

From studying this output, we are able to see that the OLS estimate of B1 is:
B1 = 0.519 (3 d.p.)
Also, that the OLS estimate of B0 is:
B0 = -80086.58
Thus, the sample regression suggests that as a result of a 1million increase in GDP, Imports
of Goods and Services will go up by 519,456 on average. This aligns with our expectations
as mentioned earlier.
Also, the value of B0 implies that when GDP is equal to zero, then our imports of goods and
services will be -80086.58. For this number to be positive, there is a certain amount of GDP
we must have. This is found by dividing -B0 by B1, which is 154,309.40 (2d.p.).
From the output, we also find the Durbin-Watson statistic, which is 0.274235 for this model.
This is a 1 variable model, with 141 observations. The corresponding set of d statistics have a
lower bound of 1.720, and an upper bound of 1.746. The given d statistic lies very well below
this range; thus we must accept that they are subject to first-order autocorrelation.

Phase 3

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If the expected disturbance is zero, B0 represents the average value of Y when X and Z are
equal to zero. B1 represents the change in the mean value of Y for each unit change of X,
when Z is held constant. B2 represents the change in the mean value of Y for each unit change
of Z when X is held constant. Therefore, when GDP and the exchange rate are zero, B0
should roughly be the value of imports of goods and services. When GDP goes up by one
unit, imports of goods and services increases by B1, with the exchange rate held constant.
When the exchange rate goes up by one unit, imports of goods and services goes up by B2,
with GDP held constant.
Z
130
120
110
100
90
80
70
1980

1985

1990

1995

2000

2005

2010

2015

Across the period shown, from 1980, to 2015, the exchange rate has decreased a significant
amount. The graph shows a peak of approximately 124 in the first quarter of 1981. Also in
the period shown, the graph shows a trough of approximately 78 in the first quarter of 2009.
This means that the exchange rate fell by 46 index points in the 28 years from 1981 to 2009.
These are index values, with 2005 as the base year.
Dependent Variable: Y
Method: Least Squares
Date: 04/19/16 Time: 20:31
Sample: 1980Q1 2015Q1
Included observations: 141
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
X
Z

-110167.6
0.535512
263.4654

4495.280
0.004868
37.46399

-24.50740
110.0005
7.032499

0.0000
0.0000
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.990665
0.990530
3796.939
1.99E+09
-1360.669
7322.618
0.000000

Mean dependent var


S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

82399.46
39017.04
19.34282
19.40556
19.36832
0.403730

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From studying the output, we are able to see that the OLS estimate of B2 is:
B2 = 263.47 (2 d.p.)
Also, that the OLS estimate of B1 is:
B1 = 0.536 (3 d.p.)
And finally, that the OLS estimate of B0 is:
B0 = -110167.6
Thus, the sample regression suggests that as a result of a 1million increase in GDP, with the
exchange rate being held constant, our imports of goods and services will go up by 535,512.
Also, that if the exchange rate goes up by 1 index point, with GDP being held constant, then
our imports of goods and services increase by 263.47. Also, that when the exchange rate
index is set to zero, and GDP is zero, our imports of goods and services will be -110167.60.
a) Ho: B1 = 0 against Ha: B1 0
Using C(2) = 0. We get the following output:
Wald Test:
Equation: Untitled
Test Statistic
t-statistic
F-statistic
Chi-square

Value

df

Probability

110.0005
12100.11
12100.11

138
(1, 138)
1

0.0000
0.0000
0.0000

Value

Std. Err.

0.535512

0.004868

Null Hypothesis: C(2)=0


Null Hypothesis Summary:
Normalized Restriction (= 0)
C(2)

Restrictions are linear in coefficients.

Studying this output, we see the t-statistic probability is less than 0.05, therefore we reject
our null hypothesis in favour of our alternate hypothesis.
b) Ho: B2 = 0 against Ha: B2 0

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Using C(3) = 0. We get the following output:


Wald Test:
Equation: Untitled
Test Statistic
t-statistic
F-statistic
Chi-square

Value

df

Probability

7.032499
49.45604
49.45604

138
(1, 138)
1

0.0000
0.0000
0.0000

Value

Std. Err.

263.4654

37.46399

Null Hypothesis: C(3) = 0


Null Hypothesis Summary:
Normalized Restriction (= 0)
C(3)

Restrictions are linear in coefficients.

Studying this, we see our t-statistic probability is less than 0.05, thus we reject the null
hypothesis in favour of our alternate hypothesis.
c) Ho: B2 = 0, B1 = 0 against Ha: at least one of B1 0, B2 0.
Using C(2) = 0, C(3) = 0. We get the following output:
Wald Test:
Equation: Untitled
Test Statistic
F-statistic
Chi-square

Value

df

Probability

7322.618
14645.24

(2, 138)
2

0.0000
0.0000

Value

Std. Err.

0.535512
263.4654

0.004868
37.46399

Null Hypothesis: C(2) = 0, C(3) = 0


Null Hypothesis Summary:
Normalized Restriction (= 0)
C(2)
C(3)

Restrictions are linear in coefficients.

Studying this, we can see the F-statistic probability is less than 0.05, thus we can reject
the null hypothesis, in favour of the alternate hypothesis, meaning at least one of B1 or B2
does not equate to zero.
There are four measures for the goodness of fit, they include the following:
Residual Sum of Squares (RSS)
Coefficient of Determination (R2)
Standard Error of the Regression ( ^
2
The Adjusted R-squared Statistic ( R

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For the first regression model, the goodness of fit measures are as follows:
RSS = 2702505...- This value indicates the amount of variance that is unexplained by the
regression model. Typically, the smaller this value is, the better.
R2 = 98.7320% - This indicates that the model explains almost all the variability of the
response data around the mean.
^ = 4409.363 - This shows us how wrong our model is, in terms of the units of Y. This is
the average distance the observed values fall from the regression line. Typically, the smaller
the number, the better.
2 = 98.7228% - This is still a very high value, thus it indicates the model has a good fit.
R
For the second regression model, the goodness of fit measures are as follows:
RSS = 1989510...- This value is smaller than that of its counterpart for the 1st regression
model, thus the 2nd model has a better goodness of fit.
R2 = 99.0665% - This indicates that the model explains almost all of the variability of the
response data around the mean, even more so than the 1st model. Thus based on this, the 2nd
model has a better goodness of fit as opposed to the 1st model.
^ = 3796.939 This value is smaller than the one for the 1st regression model, thus the
second has a better goodness of fit.
2 = 99.0530% - After adjustment it is not as high, but is still higher than that of the 1st
R
model, thus the 2nd has a better goodness of fit.
From the output, we also find the Durbin-Watson statistic, which is 0.403730 for this model.
This is a 2 variable model, with 141 observations. The corresponding set of d statistics have a
lower bound of 1.706, and an upper bound of 1.760. The given d statistic lies very well below
this range; thus we must accept that there is first order autocorrelation.

Phase 4
X
log .( t)+ B2 log .(Z t )+ut
log . ( Y t ) =B0 +B 1
This model uses the standardised form, the coefficients will determine how much Imports
responds to a change in its variables (GDP and Exchange Rate).
B1, is the (constant) partial elasticity of Imports with respect to GDP, whilst B2 is the
(constant) partial elasticity of Imports with respect to UK Effective Exchange Rate. They
provide the sensitivity of a change in these variables to a change in Imports.

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Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
LOG(X)
LOG(Z)

-16.60486
2.142638
0.164697

0.288884
0.014166
0.034264

-57.47927
151.2518
4.806740

0.0000
0.0000
0.0000

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.995280
0.995211
0.036206
0.180904
269.3573
14548.46
0.000000

Mean dependent var


S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

11.19252
0.523205
-3.778118
-3.715379
-3.752623
0.521050

An Ordinary Least squares regression show estimates of B1 and B2, as 2.1426 and 0.1647
respectively. B0 is given by the coefficient of C, which is -16.6049. The estimates show that
Imports are more sensitive to changes in GDP than it is to Effective Exchange Rate, seen by
the difference between 2.1426 and 0.1647.
For the second regression model, the goodness of fit measures are as follows:
RSS = 1989510...
R2 = 99.0665%
^ = 3796.939
2
R
= 99.0530%
For the third regression model, the goodness of fit measures are as follows:
RSS = 0.180904 This is a lot smaller in comparison to the 2nd model, thus we must accept
the 3rd model has a better goodness of fit.
R2 = 99.5280% - This is only marginally higher than that of the 2nd model, but it is higher
nonetheless. Hence, the 3rd model has a better goodness of fit.
^ = 0.036206 This is a considerable amount smaller than that of the 2nd model, thus the
3rd model has a better goodness of fit.
2 = 99.5211% - The difference compared to the unadjusted R2 is negligible, but it is still
R
higher compared to the second model. Thus we must accept that the 3rd model has a better
goodness of fit in comparison.
The Durbin-Watson statistic is displayed in the regression as 0.5211, which is comfortably
under 2. This provides evidence of positive serial correlation, so are subject to first-order
autocorrelation.

Phase 5
There is less standard error in the first model as it contains only one explanatory variable.
This will give a more accurate correlation between Imports and GDP, however this is not a
sufficient amount of variables for a reliable model. Imports are dependent on more than just
this one variable, so variable Z (Exchange Rate) being added in the second model will help
eliminate the under specificity issues from the first. Although these are not the only two

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variables affecting imports, it is preferable over the first which is even more underspecified.
An issue with the second model, is that the standard error of B0 has increased greatly, with the
addition of a second variable. All three regression models follow a fitted regression line, with
their high R-squared values. The third model gives the highest R-squared value, being only
0.0047 away from 1. The third model also uses standardised values, making it easier to
compare the two variables used. Lagged variable could instead be used, to distinguish
between short-run and long-run effects. A dynamic variable like this will help factor in timelags for import changes in a response to these variables used. All three models suffer from
first order autocorrelation, as distinguished from the Durbin-Watson tests. This could
potentially be rectified by transforming the data used. With only 2 variables, it is unlikely all
effect on Import changes will be covered.