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Exercise Sheet 1 Econometrics I, 2008/09

Exercise Sheet 1
The Multiple Regression Model
ECONOMETRICS I. UC3M
1. The specication provided below establishes a linear relationship between j = variation of
real wages and r = unemployment rate(in percentage points):
j = 8,33 0,84r + n.
a) Interpret the coecients.
b) Consider now the reciprocal function so that r
0
= 1,r (inverse unemployment rate):
j = 0,12 + 0,983r
0
+ n
0
.
Interpret the coecients.
2. In an alternative specication of the Classical Linear Regression Model, could we replace the
assumption 1(njr) = 0 for 1(n) = 0? Are the two assumptions equivalent? Is it possible
that1(n) = 0 and that 1 (njr) = 0 for All values of r? Is it possible that 1(njr) = 0 for all
r without 1(n) = 0?
(Hint: Could it possible that the average income in the United States was equal to $20,000
while the average income in each State was equal to $20,000? Could it be the case that the
average income in each State is $20,000 while the average income in the US overall diers
from that amount?).
3. Which of the following statements, if any, violates the assumptions of the CLRM?
a) Variable r
2
is the reciprocal of variable r
1
.
b) Variable r
2
is the square of variable r
1
.
c) Variable r
1
is a dummy variable taking the value of 1 for females, 0 for males and
variable r
2
is a dummy variable that takes the value of 1 for males, and 0 for females.
4. Assume that log(naqc) denotes the logarithm of monthly wage and cdnc the number of years
of education. Consider the linear model
log(naqc) = /
0
+ /
1
cdnc + .
a) Is it reasonable to assume that 1(jcdnc) = 0? What other factors would you expect to
be included in the error term n?
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Exercise Sheet 1 Econometrics I, 2008/09
b) Consider the following model
log(naqc) = ,
0
+ ,
1
cdnc + ,
2
a/i| + n
where a/i| denotes the intelligence quotient (IQ) and n satises the assumption 1(njcdnc, a/i|) =
0. Interpret coecient ,
1
. Initially the available samples do not contain any information
regarding the IQ of the employees. In the light of this we estimate the simple regression
model
\
log(naqc) = 5,97 + 0,06
(0;006)
cdnc
: = 935, 1
2
= 0,097, 1oo = 149,52.
Explain under what conditions the estimation of the parameter of cdnc by OLS is an
unbiased estimator of ,
1
. Provide a 95 % condence interval for the slope of the model.
c) Assume that upon obtaining information about the IQ of employees we arrive at the
following estimates,
\
log(naqc) = 5,66 + 0,04
(0;007)
cdnc + 0,0059
se(
^

2
)
a/i|
: = 935, 1
2
= 0,130
Using a 5 % level of signicance test the hypothesis that intelligence does not aect
wages.
d) Obtain the sample covariance between educational level and IQ. In the light of your
results, interpret the parameter associated with education in the two equations.
e) Let 1(n
2
jcdnc, a/i|) = o
2
(cdnc) , where o
2
(cdnc) is a positive function of cdnc. Would
you change any of your answers? What are the consequences of the lack of the assumption
of heteroskedasticity?
5. Let variable rdi:tc:: denote research and development expenditures (R&D) as a percentage
of sales. Sales, :a|c:, are measured in millions of dollars. Variable jro):arq stands for prots
as a percentage of sales (prot margin). Using 32 companies from the Chemical sector industry
we obtain the following equation
\
rdi:tc:: = 0,472 + 0,321
(0;216)
log (:a|c:) +
^
,
2
(0;046)
jro):arq
: = 32, 1
2
= 0,098
a) Interpret the coecient of log (:a|c:) : If sales Increase by 10 %, what would be the
estimated change ceteris paribus in rdi:tc::? Is this eect economically important? Is
it statistically signicant?
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Exercise Sheet 1 Econometrics I, 2008/09
b) Using the same data we have estimated the following alternative model:
\
rdi:tc:: = 1,104 + ,302
(0;216)
log (:a|c:)
: = 32, 1
2
= 0,061
Is the coecient of jro):arq in the model of part (a) statistically signicant? If we
knew that
^
,
2
was positive, what would have been its value?
c) Consider the model provided below relating prots to sales,
\
jro):arg = 7,34 + ^
1
se(^
1
)
log (:a|c:) .
: = 32, 1
2
= 0,0069
What are the sign and value of ^
1
? Is it statistically signicant? Obtain :c (^
1
) .
6. Using data from 680 students of Introductory Microeconomics in an American University,
researchers tted the following regression model to study the eect of class attendance on
nal course grades:
:t:d):| = ,
0
+ ,
1
at:drtc + ,
2
jriG1 (1)
+,
3
jriG1
2
+ ,
4
CT
2
+ ,
5
jriG1 at:drtc + l,
The estimation results are provided below
\
:t:d):| = 2, 05
(1;36)
0, 0067
(0;0102)
at:drtc 1, 63
(0;48)
jriG1
+0, 296
(0;101)
jriG1
2
+ 0, 0045
(0;0022)
CT
2
+ 0, 0045
(0;0022)
jriG1 at:drtc, 1
2
= 0, 222,
where :t:d):| is the standardised nal exam result, at:drtc the percentage of classes attend-
ed, jriG1 the grade point average of previous courses and CT denotes the University
entry score.
a) What is the estimated partial eect of class attendance on the nal exam? Assume that
d
Co

^
,
1
,
^
,
5

= 0,0001 Would this lead you to conclude that this eect is statistically
signicant for a student with an average score of three in previous courses?
b) Assume that we add ,
6
CT at:drtc
2
to equation (1). What would be the partial eect
of class attendance in the model in terms of the unknown parameters?
c) Explain how would you test the assertion that the model is linear in all variables i.e.
that ,
3
= ,
4
= ,
5
= 0. Clearly state all the stages that you have followed in order to
carry out the test: 1) Test statistic, explicitly stating its components and 2) Decision
rule.
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Exercise Sheet 1 Econometrics I, 2008/09
7. Regression analysis can be employed to test the assertion that the market utilizes information
eciently at the time of share evaluation. To put things into context, let rctnr: be the total
share return of a company over a period of four years, starting at the end of 1990 until
the end of 1994. The market eciency hypothesis maintains that this return shouldnt be
related in a systematic manner with the known information in 1990. If the known company
characteristics at the beginning of the period could help in predicting the product return we
could use that information to select some shares over others.
For 1990, let d/r be the capital debt ratio of the company, cj: the earnings per share, :cti:c
net income and :a|arj the total remuneration of the general manager.
a) Using the data provided in RETURN, estimate the following equation:
rctnr: = ,
0
+ ,
1
d/r + ,
2
cj: + ,
3
:cti:c + ,
4
:a|arj + n.
Using a 5 % level of signicance, test the hypothesis that the explanatory variables are
jointly statistically signicant. Test if :cti:c and :a|arj are jointly signicant. Is there
any explanatory variable that is individually statistically signicant?
b) Re-estimate the model including the logarithms of :cti:c and :a|arj,
rctnr: = ,
0
+ ,
1
d/r + ,
2
cj: + ,
3
log (:cti:c) + ,
4
log (:a|arj) + n.
Does this change the conclusions you reached in part (a)?
c) Is there any reason why we shouldnt use logarithms of d/r and cj: in part (/)?
d) Generally, is the evidence in favour of the predictability of share returns strong or weak?
8. Let the variables ALM = Annual family spending on food and, GT = Total family expendi-
ture. Consider the following alternative models:
i) |:(1') = 3,67 + 0,48 |:(GT)
ii) 1' = 164567 + 2163 |:(GT)
iii) 1',GT) 100 = 156,89 13,32 |:(GT)
(The last model is known as the "Working Lesser"specication, which considers food expen-
diture as a percentage of the total expenditure) Interpret the coecients obtained in each
model.
9. Consider the linear regression model
1
i
= ,
0
+ ,
1
A
1i
+ ,
2
A
2i
+ ,
3
A
3i
+ ,
4
A
4i
+ ,
5
A
5i
+ c
i
Explain exactly how do the following hypotheses dier?
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Exercise Sheet 1 Econometrics I, 2008/09
a) ,
1
= 0
b) ,
1
= 0 and ,
4
= ,
5
c) ,
1
= 0 , ,
4
= ,
5
and ,
3
= 0
5