ECONOMETRICS

Chrispin Mphuka
University of Zambia

January 2011

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

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frametitleAssumptions
Generic form of the linear regression model : population regression h

= f (x1 , x2 , ..., xk ) +
= x1 1 + x2 2 + ...xk k +

Classical regression model is a set of joint distributions satisfying

Assumptions 1.1 - 1.4

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frametitleClassical Linear Regression Assumptions

Linearity Assunption.
yi = xi1 1 + xi2 2 + ...xik k + i

(i = 1, 2, 3, ..., n)

(1)

where 0 s are unkown parameters to be estimated, and i is the

unobserved error term with certain properties to be specified below

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frametitleClassical Linear Regression Assumptions

Linearity Assunption.
yi = xi1 1 + xi2 2 + ...xik k + i

(i = 1, 2, 3, ..., n)

(1)

where 0 s are unkown parameters to be estimated, and i is the

unobserved error term with certain properties to be specified below
the RHS: xi 1 1 + xi 2 2 + ...xik k is called the regression function

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

3/1

frametitleClassical Linear Regression Assumptions

Linearity Assunption.
yi = xi1 1 + xi2 2 + ...xik k + i

(i = 1, 2, 3, ..., n)

(1)

where 0 s are unkown parameters to be estimated, and i is the

unobserved error term with certain properties to be specified below
the RHS: xi 1 1 + xi 2 2 + ...xik k is called the regression function
0 s are regression coefficientst that represent marginal and separate
effects of regressors

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

3/1

frametitleClassical Linear Regression Assumptions

Linearity Assunption.
yi = xi1 1 + xi2 2 + ...xik k + i

(i = 1, 2, 3, ..., n)

(1)

where 0 s are unkown parameters to be estimated, and i is the

unobserved error term with certain properties to be specified below
the RHS: xi 1 1 + xi 2 2 + ...xik k is called the regression function
0 s are regression coefficientst that represent marginal and separate
effects of regressors
e.g , 2 represents the the change in the dependent variable when the
second regressor increases by 1 unit holding constant other variables.
i.e yi /xi 2 = 2

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

3/1

frametitleClassical Linear Regression Assumptions

Linearity Assunption.
yi = xi1 1 + xi2 2 + ...xik k + i

(i = 1, 2, 3, ..., n)

(1)

where 0 s are unkown parameters to be estimated, and i is the

unobserved error term with certain properties to be specified below
the RHS: xi 1 1 + xi 2 2 + ...xik k is called the regression function
0 s are regression coefficientst that represent marginal and separate
effects of regressors
e.g , 2 represents the the change in the dependent variable when the
second regressor increases by 1 unit holding constant other variables.
i.e yi /xi 2 = 2
Linearity implies that the marginal effects do not depend on the level of
regressors

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

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frametitleClassical Linear Regression Assumptions

Linearity Assunption.
yi = xi1 1 + xi2 2 + ...xik k + i

(i = 1, 2, 3, ..., n)

(1)

where 0 s are unkown parameters to be estimated, and i is the

unobserved error term with certain properties to be specified below
the RHS: xi 1 1 + xi 2 2 + ...xik k is called the regression function
0 s are regression coefficientst that represent marginal and separate
effects of regressors
e.g , 2 represents the the change in the dependent variable when the
second regressor increases by 1 unit holding constant other variables.
i.e yi /xi 2 = 2
Linearity implies that the marginal effects do not depend on the level of
regressors
Example: (Wage Equation)
log(WAGEi ) = 1 + 2 Si + 3 TENUREi + 4 EXPRi + i

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Lecture 1: Classical Regression Model

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frametitleClassical Linear Regression Assumptions

Xi =

xi1
xi2
.
.
.
xik

fi =

1
2
.
.
.
k

thus Xi0 fi =xi1 1 + xi2 2 + ...xik k and

yi = Xi0 fi + i , (i = 1, 2, ..., n )

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frametitleClassical Linear Regression Assumptions

Also defined

y =

y1
.
.
.
yn

1
.
.
.
n

X =

X10
.
.
.
Xn0

x11 . . . x1K
.
.
. . . .
xn1 . . . xnK

Therefore assumption1.1 can be written as:

y = Xfi +

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)
E ( i |X) = 0

Chrispin Mphuka (Institute)

(i = 1, 2, ..., n)

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)
E ( i |X) = 0
(i = 1, 2, ..., n)
differently put implies E ( i |X1 , ..., Xn ) = 0

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

(i = 1, 2, ..., n)

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)
E ( i |X) = 0
(i = 1, 2, ..., n)
differently put implies E ( i |X1 , ..., Xn ) = 0

(i = 1, 2, ..., n)

Implications of Strict Exogeneighty

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Lecture 1: Classical Regression Model

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)
E ( i |X) = 0
(i = 1, 2, ..., n)
differently put implies E ( i |X1 , ..., Xn ) = 0

(i = 1, 2, ..., n)

Implications of Strict Exogeneighty

The unconditional mean if the error term is 0 i.e
(i = 1, 2, ..., n)

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

E ( i ) = 0

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)
E ( i |X) = 0
(i = 1, 2, ..., n)
differently put implies E ( i |X1 , ..., Xn ) = 0

(i = 1, 2, ..., n)

Implications of Strict Exogeneighty

The unconditional mean if the error term is 0 i.e E ( i ) = 0
(i = 1, 2, ..., n)
If cross moments E (xy ) = 0 = x is orthogonal to y. Under strict
exogeneity the
regressors are orthogonal to the error terms.
i.e., E xjk i = 0 (j, k = 1, ..., n; k = 1, ..., K )

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

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frametitleClassical Linear Regression Assumptions

Assumption 1.2 (Strict Exogeneity)
E ( i |X) = 0
(i = 1, 2, ..., n)
differently put implies E ( i |X1 , ..., Xn ) = 0

(i = 1, 2, ..., n)

Implications of Strict Exogeneighty

The unconditional mean if the error term is 0 i.e E ( i ) = 0
(i = 1, 2, ..., n)
If cross moments E (xy ) = 0 = x is orthogonal to y. Under strict
exogeneity the
regressors are orthogonal to the error terms.
i.e., E xjk i = 0 (j, k = 1, ..., n; k = 1, ..., K )

Strict exogeneity resquires that the regressors be orthorgonal not only

to the error term from the same observation but also to the error
term from other observations.

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Lecture 1: Classical Regression Model

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frametitleClassical Linear Regression Assumptions

Assumption 1.3: No multicollinearity
- the rank of the nXK data matrix, X, is K with probability 1.
-implies X is a full column rank
-implies that n > k i.e., there must be at least as many observations
as variables.

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

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frametitleClassical Linear Regression Assumptions

Assumption 1.3: No multicollinearity
- the rank of the nXK data matrix, X, is K with probability 1.
-implies X is a full column rank
-implies that n > k i.e., there must be at least as many observations
as variables.
Assumption 1.4: Spherical error

variance
2
- (homoskedasticity) E i |X = 2 > 0 (i = 1, 2, ..., n )






Var 2i |X = E 2i |X E ( i |X)2 = E 2i |X , since E ( i |X) = 0
by assumption

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Lecture 1: Classical Regression Model

01/2010

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frametitleClassical Linear Regression Assumptions

Assumption 1.3: No multicollinearity
- the rank of the nXK data matrix, X, is K with probability 1.
-implies X is a full column rank
-implies that n > k i.e., there must be at least as many observations
as variables.
Assumption 1.4: Spherical error

variance
2
- (homoskedasticity) E i |X = 2 > 0 (i = 1, 2, ..., n )






Var 2i |X = E 2i |X E ( i |X)2 = E 2i |X , since E ( i |X) = 0
by assumption
The homoskedaisticity assumption says that the conditional second
moment is a constant
-(no correlation between errors) E ( i j |X) = 0
(i = 1, 2, ..., n; i 6= j )

Chrispin Mphuka (Institute)

Lecture 1: Classical Regression Model

01/2010

7/1

frametitleClassical Linear Regression Assumptions

Assumption 1.3: No multicollinearity
- the rank of the nXK data matrix, X, is K with probability 1.
-implies X is a full column rank
-implies that n > k i.e., there must be at least as many observations
as variables.
Assumption 1.4: Spherical error

variance
2
- (homoskedasticity) E i |X = 2 > 0 (i = 1, 2, ..., n )






Var 2i |X = E 2i |X E ( i |X)2 = E 2i |X , since E ( i |X) = 0
by assumption
The homoskedaisticity assumption says that the conditional second
moment is a constant
-(no correlation between errors) E ( i j |X) = 0
(i = 1, 2, ..., n; i 6= j )
The two assumptions combined = E (0 |X) = 2 In or equivalently
Var (0 |X) = 2 In
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Lecture 1: Classical Regression Model

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frametitleClassical Linear Regression Assumptions

Random Sample
-Assume (yi ,Xi ) is a random sample = (yi ,Xi ) is iid accros
distributions

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Lecture 1: Classical Regression Model

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frametitleClassical Linear Regression Assumptions

Random Sample
-Assume (yi ,Xi ) is a random sample = (yi ,Xi ) is iid accros
distributions
Then
-E ( i |X)
= E ( i |xi )

-E 2i |X = E 2i |xi

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Lecture 1: Classical Regression Model

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frametitleClassical Linear Regression Assumptions

Random Sample
-Assume (yi ,Xi ) is a random sample = (yi ,Xi ) is iid accros
distributions
Then
-E ( i |X)
= E ( i |xi )

-E 2i |X = E 2i |xi
and E ( i j |X) = E ( i |xi ) E ( j |xj )

Chrispin Mphuka (Institute)

(i 6 = j )

Lecture 1: Classical Regression Model

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frametitleAlgebra of Least Squares

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frametitleWorking with color

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frametitleAdding graphics
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2015-04-02

Lecture 1: Classical Regression Model

The Classical Multiple Linear Regression Model
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