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Heteroskedasticity
Objectives
What is heteroskedasticity?
What are the consequences?
How is heteroskedasticity identified?
How is heteroskedasticity corrected?
ECON 7710, 2010
10.2
22.14
0.031
R 0.3171, N 40.
2
10.3
billion
10.4
Regression Model
10.5
Yi = 0 + 1X1i + 2X2i + i
zero mean:
E(i|X1i,X2i) = 0
homoskedasticity:
var(i|X1i,X2i) = 2
10.6
Identical distributions for
observations i and j
Distribution for i
Distribution for j
10.7
Homoskedasticity
Yi = 0 + 1Xi + i
var(i|Xi) = 2 for all i
Y
f(Y)
.
0
X1
X2
X3
X4
Conditional
ECON Distribution
7710, 2010
10.8
Heteroskedasticity
Yi = 0 + 1Xi + i
var(i|Xi) = i2 for all i
7710, 2010
ConditionalECON
Distribution
10.9
10.10
10.11
Pure heteroskedasticity
Different variances of the error term.
Correctly specified PRF.
Impure heteroskedasticity
Different variances of the error term.
Specification error.
ECON 7710, 2010
10.12
2. Detecting Heteroscedasticity
2.1 Graphical Method
Plotting foodexp against income
(for one regressor)
280
200
foodexp
Example 1:
Food expenditure,
US Data
(UE_Tab0301)
240
160
120
80
40
200
400
600
800
income
1,000
1,200
10.13
Plotting e2 against
income.
7,000
120
6,000
80
squared residual
5,000
residual
40
4,000
3,000
2,000
-40
-80
200
1,000
400
600
800
income
1,000
1,200
0
200
400
600
800
income
1,000
1,200
10.14
R 2 0.6182, N = 33.
40,000
30,000
residual
20,000
10,000
0
-10,000
-20,000
-30,000
0
ECON
7710, 2010
Population
10.15
10.16
ei Yi Yi Yi
0 1 X 1i L K X Ki
Step 2: Regress the natural log of squared
residuals on the natural log of a possible
proportionality factor
ln(ei2) = 0 + 1lnZi + vi
where vi is an error term satisfying all classical
assumptions.
ECON 7710, 2010
10.17
Step 3
If the coefficient of lnZ is significantly
different from zero, then it would suggest that
there is heteroscedastic pattern in the residuals
with respect to Z. Otherwise, homoscedastic errors
cannot be rejected.
Example 3: Park Test: US data (UE_Tab0301)
^
ln(e2) = -7.46 + 2.07** ln(income)
t
(2.28)
p-value
(0.0284)
ECON 7710, 2010
10.18
10.19
10.20
ei Yi Yi Yi
0 1 X 1i 2 X 2 i
Step 2: Regress the squared residuals on all
explanatory variables, all cross product terms and
the square of each explanatory variable.
ei2 = 0 + 1X1i + 2X2i
+ 3X1i2 + 4X2i2
+ 5X1iX2i + vi
10.21
10.22
10.23
3. Consequences of Heteroskedasticity
If heteroskedasticity appears but OLS is
used for estimation, how are the OLS
estimates affected?
Unaffected: OLS estimators are still linear and
unbiased because, on average, overestimates
are as likely as underestimates.
E k k
k 0,1, , K
ECON 7710, 2010
10.24
10.25
var
ols
var hetero
k
k
biased se k
10.26
4. Remedies
4.1 Heteroskedasticity-Corrected
Standard Errors
Yi = 0 + 1X1i + 2X2i + i
heteroskedasticity:
var(i) = i2
10.27
10.28
Example 5:
Yi = 0 + 1Xi + i, var(i|Xi) = i.
incorrect
variance formula:
var
1
X X
correct
variance formula:
var 1
2
2
i X i X
2
2
Xi X
Xi X
22.14
24.32
0.031
0.039
R 2 0.3171,ECON
N =7710,
40. 2010
10.29
10.30
Yi = 0 + 1X1i + 2X2i + i
E(i) = 0
var(i) = i2
cov(t, s) = 0
i2 = c Zi 2
ECON 7710, 2010
t =s
The variance is
assumed to be
proportional to
the value of Zi2
10.31
10.32
10.33
foodexp
1
***
0.1577 21.2858
0.02342
14.0380 income
income
se
R 2 0.0570, N = 40.
10.34
OLS estimate
40.77
0.128***
OLS se
22.14
0.031
HC se
24.32
0.039
0.158***
WLS se
0.023
14.03
10.35
Other possibilities
var(i) = cZi
var(i) = cZi
var(i) = c(a1X1i + a2X2i)
ECON 7710, 2010
10.36
10.37
se
0.90
0.14
R 2 0.4014, N = 40.
10.38
50.86
0.078
R 0.3698, N = 55.
2
10.39
***
0.78
0.12
R 2 0.4125, N = 55.
HC
WLS
50.86
43.26
0.078
0.074
foodexp
1
**
***
76.5439
0.4650 .
37.9435
totexp
totexp 0.0632
se
10.40
10.41
(1)
(2
)
se
radio
weekend
176
293
stad
stad
revenue
adv
stad
cd
22 2.21
109
7.93
pop
pop
pop
pop
(3
) 2.53radio 4.28weekend
Remarks:
10.42
10.43
5. A Complete Example
Sources: Section 8.2.2 (pp. 255 256)
Section 10.5 (pp. 369 376)
taxi
ECON wihtin
7710, 2010
uhm : urban highway miles
the ith state
10.44
Equation 1
^ = 389.57*** 0.061reg 36.47***tax + 60.76***uhm se,
pcon
vif
(0.04, 24.3) (13.15, 1.1) (10.26, 24.9)
Adj. R2 = 0.9192, N = 50.
Equation 2
^ = 551.69*** + 0.19***reg 53.59***tax
pcon
se
(0.012)
Adj. R2 = 0.8607, N = 50.
(16.86)
10.45
Graphical investigation
1,200
residual
800
400
0
-400
-800
5,000
10,000
15,000
REG
20,000
Park test
^
ln(e2) = 1.65 + 0.95***ln(REG)
se
10.46
R2 = 0.1657, N = 50
(0.3083)
White test
^e2 = 11,098,291 + 140REG 0.0005REG2
12.84REGTAX 237,873TAX + 12347TAX2.
R2 = 0.6645, N = 50, NR2 = 33.22.
Checking for other specifications:
Double log, quadratic
ECON 7710, 2010
10.47
(4)
(5)
R 2 0.3600, N 50
(6)
pcon
reg
***
**
0.1684 0.1082
0.0103 tax
0.07159 pop
0.00349
pop
se
R 2 0.1989, N 50
ECON 7710, 2010
Selected
Exercises
Ch. 10: Q. 1, 3, 4, 5, 8, 10, 12, 14
10.48
Regression Model
10.49
Yi = 0 + 1X1i + 2X2i + i
zero mean:
E(i|X1i,X2i) = 0
homoskedasticity:
var(i|X1i,X2i) = 2
var(i|X1i,X2i) = i2
10.50
Heteroskedasticity
Yi = 0 + 1Xi + i
var(i|Xi) = i2 for all i
Y
f(Y)
.
0
X1
X2
X3
7710, 2010
ConditionalECON
Distribution
.
X
10.51
10.52
Zi
Zi
Zi
Zi
Zi
*
*
*
*
*
Yi 0 X 0i 1X1i 2 X 2i i
10.53
Yi
1
X1i
i
0 1
2
Zi
Zi
Zi
Zi
Y 0 X 1X 2
*
i
*
0i
*
1i
*
i
10.54