ETC2410 Lecture slides Semester 1 2019 Monash University Clayton Campus

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ETC2410 Lecture slides Semester 1 2019 Monash University Clayton Campus

© All Rights Reserved

- Nonparametric Notes
- Syllabus0701F10
- A Novel Flotation Column for Oily Water Cleanup
- Syllabus 582
- Kennedy a Guide to Econometrics
- Sunk Cost Fallacy
- Seznam Literatury o Statistice
- Super Cycles in Real Metals Prices
- econ349syllabus-2015
- English Class Structure
- Prediction of Slug Length In
- 12 Tips for Accurate Project Estimating
- Online Econometrics Assignment Help Service
- 4 Cumulative Production Forecast of an Oil
- ileanu
- Expert Elicitation Method Selection Process
- Guide to Predictive Modelling
- 002-2-01.07
- Materi Correlational Research
- PREDICTION THE NUMBER OF PATIENTS AT DENGUE HEMORRHAGIC FEVER CASES USING ADAPTIVE NEURAL FUZZY INFERENCE SYSTEM (ANFIS)

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2019

2019

1 / 38

Welcome

most third year units in econometrics, business analytics and

actuarial studies

I You are certainly in the right place to learn econometrics

2 / 38

What is Econometrics?

those measurements. “Econo” tells us that we are talking

about measuring and analysing economic things.

I Other examples of quantitative analytics in other fields are

biometrics and psychometrics

I Remember that this was coined in 1930, when many of the

business and commerce disciplines of today were at their

infancy or did not exist, so the context was ”Econo” not

“Busino” (“Businometrics” does not sounds very good to me)

I Econometric methods are used in economics, finance,

marketing and management

I Econometrics uses mathematics and statistics

3 / 38

Outline of unit

I Week 1: Introduction

I Week 2: Review of Statistical Concepts

I Week 3: Linear Regression (OLS)

I Week 4: More on Linear Regression Analysis

I Week 5: Inference

I Week 6: Model Selection / Prediction

I Week 7: Binary Variables

I Week 8: Heteroskedasticity

I Week 9: Serial Correlation

I Week 10: Persistence in Time Series Data

I Week 11: Large Sample Properties of OLS

I Week 12: Revision

4 / 38

Logistics

5 / 38

Overall goal

problems quotes . This comprises the following stages:

1. Understanding the problem

2. Formulating an appropriate conceptual model to tackle the

problem

3. Collecting appropriate data

4. Looking at data (Descriptive Analytics)

5. Estimating the model, making inference, predictions and

policy prescriptions as appropriate (Predictive and Prescriptive

Analytics)

6. Evaluating, learning and improving each of the previous steps,

and iterating until the problem is solved

6 / 38

Two purposes of econometric modelling

1. Prediction: To predict a target variable based on available

information, e.g.,

I future return to a stock based on historical returns

I school quality based on house prices

I rain and its intensity based on the number of people carrying

umbrellas

2. Policy prescription: To understand the causes of variation in a

target variable, so that we can control that variable with

suitable policy prescriptions, e.g.

I what determines the volatility of stock prices?

I what determines the demand for umbrellas?

I how does university education affect earnings?

I what is the effect of greenhouse gases on global temperature?

7 / 38

Two purposes of econometric modelling: 1. Prediction

target variable y ?

8 / 38

Two purposes of econometric modelling: 1. Prediction

target variable y ?

I Can we predict how many people will be carrying umbrellas

using the weather bureau’s forecast of incidence and intensity

of rain?

8 / 38

Two purposes of econometric modelling: 1. Prediction

target variable y ?

I Can we predict how many people will be carrying umbrellas

using the weather bureau’s forecast of incidence and intensity

of rain?

I Can we predict if it is raining outside by counting how many

people enter the lecture theatre with umbrellas?

8 / 38

Two purposes of econometric modelling: 1. Prediction

target variable y ?

I Can we predict how many people will be carrying umbrellas

using the weather bureau’s forecast of incidence and intensity

of rain?

I Can we predict if it is raining outside by counting how many

people enter the lecture theatre with umbrellas?

I The answer to both questions is ‘yes’. We can exploit

correlation for prediction, regardless of the direction of

causation.

8 / 38

Two purposes of econometric modelling: 1. Prediction

Predictive models

correlated with y .

I If there are several variables that are correlated with y , these

tools will allow us to use a combination of these predictors to

predict y .

I When we have time series data, and today’s value is

correlated with yesterday’s value, these tools allow us to use

yesterday’s value to predict today.

I Prediction of future values is called forecasting. The tools we

learn allow us to build forecasting models.

9 / 38

Two purposes of econometric modelling: 2. Policy

Prescription

Causal models

changing a variable x?

10 / 38

Two purposes of econometric modelling: 2. Policy

Prescription

Causal models

changing a variable x?

I Example 1: CEO salary is positively correlated with a

company’s share price. Can we increase a company’s share

price by offering a large salary to its CEO?

10 / 38

Two purposes of econometric modelling: 2. Policy

Prescription

Causal models

changing a variable x?

I Example 1: CEO salary is positively correlated with a

company’s share price. Can we increase a company’s share

price by offering a large salary to its CEO?

I Example 2: Poor countries have high infant mortality. Does

this mean that the only way to reduce infant mortality is to

make the country rich?

I We need to have a causal model to enable us to give policy

advice. For example, after taking account for all confounding

factors, we establish that better sanitation reduces child

mortality. Then we can advise the country or NGOs to

implement programs to improve sanitation in order to reduce

child mortality.

10 / 38

The role of economics and finance theories

I Theories in economics and finance suggest how variables are

related to each other. Hence they are potentially useful for

developing causal and also predictive models. Examples:

I Economic theory suggests that quantity demanded is

negatively related to own price and positively related to income

of consumers.

11 / 38

The role of economics and finance theories

I Theories in economics and finance suggest how variables are

related to each other. Hence they are potentially useful for

developing causal and also predictive models. Examples:

I Economic theory suggests that quantity demanded is

negatively related to own price and positively related to income

of consumers.

I Finance theory suggests that bond prices depend negatively on

inflation. This implies that predictors that are useful for

predicting inflation should also help in predicting bond prices.

11 / 38

The role of economics and finance theories

I Theories in economics and finance suggest how variables are

related to each other. Hence they are potentially useful for

developing causal and also predictive models. Examples:

I Economic theory suggests that quantity demanded is

negatively related to own price and positively related to income

of consumers.

I Finance theory suggests that bond prices depend negatively on

inflation. This implies that predictors that are useful for

predicting inflation should also help in predicting bond prices.

I Also, we can use econometrics to test economics and finance

theories. For example:

I The efficient market hypothesis implies that all important

information for next period’s equity prices is in this period’s

price. Hence equity returns should be unpredictable. If we can

find a significant predictor for returns, we can reject this

hypothesis.

11 / 38

Some examples

I What is the effect of reducing class size on student

achievement?

I How does another year of education change earnings?

I What determines if a person chooses to buy private health

insurance?

I What is the price elasticity of cigarettes?

I What is the effect on output growth of a 0.25 percentage

point increase in interest rates?

12 / 38

Let’s think of bigger issues: What do YOU think?

1. Global warming

2. Inequality and poverty

3. Ageing of the population

4. Threat of terrorism

13 / 38

Econometric Analysis: Data

I The gold standard for measuring causal effects is using data

from randomised control trials (RCTs), similar to the way the

effectiveness of new drugs or vaccines are measured

I Such data is called experimental data

I Unfortunately, in business and economics we cannot run

experiments

I Most often econometric analysis has to be carried out using

observational (i.e. non-experimental) data.

I Returns to education: data on wage and educational

attainment of a sample of individuals.

I Confounding effects (omitted factors): smarter individuals go

to university. University graduates get higher wages. Is this

wage differential a return to university education or a return to

smartness?

14 / 38

Econometric Analysis: Structure of data

I Three data structures that are commonly encountered in

econometrics:

1. Cross-sectional data: observations on one or more variables

taken at the same point in time.

I e.g. Observations on infant mortality and GDP per capita in a

group of countries in 2015.

at different points in time.

I e.g. Monthly observations on returns and volume of trade of

Qantas shares from January 2000 to June 2018.

cross-section units at different points in time.

I e.g. Daily returns and volumes for ASX200 companies from

2/1/2017 to 30/6/2018.

15 / 38

Cross-sectional versus Time series

cross-sectional and time series data:

P1 There is no natural ordering of observations in cross-sectional

data, i.e. there is no reason to assume that the characteristics

of Helen should be studied before those of Paul and vice versa.

P1’ Conversely, observations in time series data are ordered: There

is a natural ordering in time in the sense that GDP in quarter 1

of the year precedes quarter 2 and quarter 2 precedes quarter 3

P2 Cross-sectional data are generally assumed to be independent,

i.e. information collected on individual 1 does not provide any

information on individual 2

P2’ Conversely, time series data are generally characterized by

some form of temporal dependence, i.e. an observation on

cigarette consumption in July 2018 can be informative about

cigarette consumption in August 2018.

16 / 38

Cross-sectional versus Time series

tasks for which cross-sectional data are inadequate. These are

to:

I Forecast future values of a variable: eg. stock prices, consumer

price index, gross domestic product, annual homicide rates one

or several days /months /quarters / years ahead.

I Estimate the dynamic causal effect of one variable x on

another variable y : eg. estimate the effect on alcohol

consumption of an increase in the tax on alcohol, both initially

and subsequently as consumers adjust to the new tax.

17 / 38

Cross-sectional versus Time series: Notation

I Conventionally, a regression model for cross section analysis is

written as:

schools, cities, states, countries etc

I For time series analysis a similar regression model is written as:

years etc

I All that changes in these two expressions is the notation for

units (from i to t)

I The remaining parts of these equations will be studied in

detail in subsequent lectures

18 / 38

Econometric Analysis: Modelling

I The fundamental step is to think of all variables as random

variables (variables with several possible outcomes that have a

probability distribution)

I Equally as important is to remember that with no

information, the best prediction of a variable is the centre of

its distribution (typically its mean)

I Example: If we have a random sample of weekly wages in

Australia and based on that want to predict the wage of a

random person in Australia (not in our sample), what do we

do?

I Answer: ...

19 / 38

Econometric Analysis: Modelling

I The fundamental step is to think of all variables as random

variables (variables with several possible outcomes that have a

probability distribution)

I Equally as important is to remember that with no

information, the best prediction of a variable is the centre of

its distribution (typically its mean)

I Example: If we have a random sample of weekly wages in

Australia and based on that want to predict the wage of a

random person in Australia (not in our sample), what do we

do?

I Answer: ...

I If we group Australian population by age, the centre of the

wage distribution for different ages will not be the same

I To learn about mean of wage for each age, what should we

do?

I Calculating the average wage for each age in our sample is

not feasible (our sample may not have all ages in it) go to data

19 / 38

Econometric Analysis: Modelling - interaction of theory

and practice

Distribution of wage conditional on different values of age

f (wage | age)

wage

20

40 age

60

20 / 38

Econometric Analysis: Modelling - interaction of theory

and practice

Distribution of wage conditional on different values of age

f (wage | age)

wage

20

40 age

60

21 / 38

Econometric Analysis: Modelling - interaction of theory

and practice

of the conditional expectation line from the data

I Find the best fitting (regression) line to the scatter plot of the

data

I We study the regression line and establish why it is the best

we can do

22 / 38

Econometric Analysis: Modelling - interaction of theory

and practice

I In the theory universe, we generalise the model to

E (wage | age, educ, IQ ) = β 0 + β 1 age + β 2 educ + β 3 IQ

I In the data universe, we find the combination of age,

education and IQ that fits the wage data best

I We study why this is the best we can do

I We also learn how to incorporate information that is

qualitative, e.g. gender and occupation.

23 / 38

Econometric Analysis: Modelling - The Main Focus

tool for empirical analysis. We learn how to estimate regression

models, how to interpret them, and how to make inference,

predict and prescribe policy advice on the basis of these models.

24 / 38

Summary

prescribe policy

I The data available in business and economics are often

observational data

I Observational data sets are either cross sectional, or time

series or panel (longitudinal) data sets

I Regression modelling is a powerful tool for econometric

analysis

25 / 38

Quotes by Jim Barksdale

co-chairman of Spread Networks. He is known for his managerial

skills.

“You cannot manage that which you cannot measure.”

opinions, lets go with mine.”

Back to overview

26 / 38

Global Warming

I Question: Can we control this warming by reducing the

human activities that produce green house gases?

I This translates to econometric questions such as:

27 / 38

Global Warming

I Question: Can we control this warming by reducing the

human activities that produce green house gases?

I This translates to econometric questions such as:

I What is the nature of the warming trend in temperatures?

27 / 38

Global Warming

I Question: Can we control this warming by reducing the

human activities that produce green house gases?

I This translates to econometric questions such as:

I What is the nature of the warming trend in temperatures?

I What causes a warming trend in temperatures?

27 / 38

Global Warming

I Question: Can we control this warming by reducing the

human activities that produce green house gases?

I This translates to econometric questions such as:

I What is the nature of the warming trend in temperatures?

I What causes a warming trend in temperatures?

I What is the sensitivity of global temperatures to green house

gas emissions?

27 / 38

Global Warming: Data

Global temperature anomalies (GTA)

0.6

0.4

0.2

GTA

0.0

−0.2

−0.4

Year

temperatures minus the 1961-1990 average)

28 / 38

Global Warming: Data

Greenhouse gases (GHG)

3.5

3.0

2.5

2.0

GHG

1.5

1.0

0.5

0.0

Year

Figure: GHG: Green House Gasses (An index that includes CO2 , CH4 ,

N2 O and CFC constructed by NASA)

29 / 38

Global Warming: Data Analysis

S catter pl ot of GTA aga inst G HG

.6

.4

.2

.0

GTA

-.2

-.4

-.6

0 1 2 3 4

GHG

30 / 38

Global Warming: Data Analysis

.6

.4

.2

.0

GTA

-.2

-.4

-.6

0 1 2 3 4

GHG

31 / 38

Global Warming: Data Analysis

OLS regression fitted values

0.6

0.4

Global Temperature Anomalies

OLS Fitted Values

0.2

GTA

0.0

−0.2

−0.4

Year

Figure: Predicted GTA using GTA

32 / 38

Global Warming: Data Analysis

33 / 38

Global Warming: Data Analysis

I Things we need to pay attention to:

1. Possibility of spurious regression due to trend.

2. Possibility of better estimation of this relationship exploiting

the persistence in errors.

3. Feedback of temperatures on greenhouse gases.

I We learn how to pay attention to some but not all of the

above in this unit.

Back to problems

33 / 38

Poverty and Inequality

development goal.

I A blatant evidence of poverty and inequality among nations is

variation in child mortality.

I Obviously poorer nations have higher child mortality. But is

that the best policy advice we can provide: increase GDP per

capita and that will reduce child mortality?

34 / 38

Poverty and Inequality

development goal.

I A blatant evidence of poverty and inequality among nations is

variation in child mortality.

I Obviously poorer nations have higher child mortality. But is

that the best policy advice we can provide: increase GDP per

capita and that will reduce child mortality?

I We need to determine that after controlling for GDP per

capita (i.e. in countries with similar GDP per capita) what

other factors determine variations in child mortality.

34 / 38

Poverty and Inequality

development goal.

I A blatant evidence of poverty and inequality among nations is

variation in child mortality.

I Obviously poorer nations have higher child mortality. But is

that the best policy advice we can provide: increase GDP per

capita and that will reduce child mortality?

I We need to determine that after controlling for GDP per

capita (i.e. in countries with similar GDP per capita) what

other factors determine variations in child mortality.

I Multiple regression analysis allows us to do that.

34 / 38

Poverty and Inequality: Data

I Data from the World Bank Development Indicators (WDI)

data set

I Countries with highest and lowest under-5 mortality rates (per

1000 live births) in 2015

35 / 38

Poverty and Inequality: Data Analysis

80

120,000 80

GDP_PERC APIT A

BASIC_WAT ER

60

SANIT AT ION

80,000 60

40

40,000 40

20

0 20 0

0 40 80 120 160 0 40 80 120 160 0 40 80 120 160

variables

36 / 38

Poverty and Inequality: Data Analysis

37 / 38

Poverty and Inequality: Data Analysis

I There are important issues surrounding the implementation of

sanitation and water purification programs: how to persuade

people to participate? How to evaluate the success of such

programs?

I Modern Development Economics includes a great deal of field

work on program implementation and program evaluation.

I These areas are important areas in economics where

experimental data is being created and analysed (including

important work by Monash staff and students in Indonesia,

India and Timor Leste).

Back to problems

38 / 38

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