Revision Guideline and Solved Problems JAN2018

Econometrics – Revision Guideline (January 2018)
A. Simple Regression Model

B. Multiple Regression Model
C. Assumptions of the CLRM
D. EVIEWS
E. Simultaneous equations models
F. Time series
A. Simple regression model
References: Lectures 1 to 5
Seminars 1 to 5
Gujarati book: chapters 1 to 5
Main contents:
 Estimating the parameters of the simple regression model
 Economic interpretation of the estimates
 Testing the significance of the parameters (t-test)
 Confidence intervals for the parameters
 Testing the significance for the coefficient of correlation
 ANOVA
 F- test – testing the validity of the model
 Coefficient of determination (R2)
 Forecasting
For part A please find below four problems with answers. The first problem is given with the
extended solution, while for the following three problems you have the solution (in short) and the
answers.
1
Lecturer PhD. Smaranda Cimpoeru, Econometrics / Finance ASE Bucharest / 2nd Year / 2018
Problem 1
In order to study the correlation between income and fertility rate a sample of 10 countries is chosen. The
following model is estimated:
𝐹𝑒𝑟𝑡𝑖𝑙𝑖𝑡𝑦 𝑟𝑎𝑡𝑒 = 2.8451 − 0.0688 ∗ 𝐺𝐷𝑃𝐶 + 𝑢̂
Where:
Fertility rate = the number of children that would be born to a woman if she were to live to the end of her
childbearing years and bear children in accordance with age-specific fertility rates of the specified year
(indicator registered for 2014).
Source: http://data.worldbank.org/indicator/SP.DYN.TFRT.IN?
GDPc = GDP per capita is gross domestic product divided by midyear population. Data are in thousand
current U.S. dollars (indicator registered for 2014).
Source: http://data.worldbank.org/indicator/NY.GDP.PCAP.CD
The following are also given:

 The estimated residuals : 0.32; 0.8; -0.18; -0.53; -0.24; -0.12; -0.2; -0.009; -0.12; 0.29.
 The average GDP / capita for the countries in the sample was 17.46 thousand $/capita.
 ∑ 𝐹𝑒𝑟𝑡𝑖𝑙𝑖𝑡𝑦 𝑟𝑎𝑡𝑒𝑖2 = ∑ 𝑦𝑖2 = 29.3
 The variance of the explanatory variable in the model is 21.4.
The entire data set is found in the table below – take a look at the fertility rates. What is the value of the
fertility replacement rate for a population? How many countries in the sample have the value above 2?
Look-up the data for all countries and notice the fertility rates for the European countries – relate this to
the “aging” society phenomenon).
Table 1 – Problem 1 Data set
Country GDP/capita Fertility rate
ths $ 2014 2014
Argentina 12.3 2.322
Kazakhstan 13.1 2.74
Russian Federation 14 1.7
Hungary 14.02 1.35
Latvia 15.7 1.52
Lithuania 16.5 1.59
Slovak Republic 19 1.34
Czech Republic 20 1.46
Portugal 22 1.21
Korea, Rep. 28 1.205
Sources:
http://data.worldbank.org/indicator/SP.DYN.TFRT.IN?
http://data.worldbank.org/indicator/NY.GDP.PCAP.CD
2
Requests
a) Interpret the estimates from an economic point of view.
b) Estimate a 95% confidence level for the slope of the model.
c) Test the significance of the two parameters for a 95% confidence level.
d) Fill in the ANOVA table.
e) Test the validity of the model using the statistic F (significance level 0.05).
f) Calculate and interpret the coefficient of determination.
g) Assuming a linear relationship between the two variables, calculate the coefficient of
correlation and test its significance for a 95% confidence level.
h) Estimate a confidence interval for the fertility rate of a country with a GDP/capita of 15 ths $/
capita.
Solution
a) Interpret the estimates from an economic point of view.

The estimated model is:
𝐹𝑒𝑟𝑡𝑖𝑙𝑖𝑡𝑦 𝑟𝑎𝑡𝑒 = 2.8451 − 0.0688 ∗ 𝐺𝐷𝑃𝐶 + 𝑢̂
 There is an inverse correlation between income and fertility, since the slope estimator is negative.
The higher the GDP/ capita of a human population (associated with a higher degree of education),
the fewer children are born --- „the demographic-economic paradox”. More references on the
subject can be found : http://ageconsearch.umn.edu/bitstream/28500/1/dp050925.pdf
 The slope estimator can be interpreted as such: for an increase in the GDP/capita with 1000$, the
fertility rate decreases with 0.0688.
 Or to make the interpretation more meaningful: the fertility rate decreases with 1 child when the
country’s GDP increases with approximately 14.5 thousand $ (how was this calculated?)
Before proceeding with the other requests we will revert to the usual notation used throughout the
econometrics course.
Y = Fertility rate = dependent variable
X = GDP/capita = explanatory variable
Considering the data given in the problem we have:
A sample of 10 countries is chosen

 𝑛 = 10
From the estimated model: 𝐹𝑒𝑟𝑡𝑖𝑙𝑖𝑡𝑦 𝑟𝑎𝑡𝑒 = 2.8451 − 0.0688 ∗ 𝐺𝐷𝑃𝐶 + 𝜀̂ ⇒
 𝛽 ̂1 = 2.8451 ; 𝛽
̂2 = −0.0688.
The estimated residuals 𝜀̂𝑖 : 0.32; 0.8; -0.18; -0.53; -0.24; -0.12; -0.2; -0.009; -0.12; 0.29.
Thus, 𝑅𝑆𝑆 = ∑ 𝜀̂𝑖2 = 0.322 + 0.82 + (−0.18)2 + ⋯ + (−0.009)2 + (−0.12)2 + 0.292 = 1.26
 𝑅𝑆𝑆 = 1.26
The average GDP / capita for the countries in the sample was 17.46 thousand $/capita.
 𝑥̅ = 17.46
3
∑ 𝐹𝑒𝑟𝑡𝑖𝑙𝑖𝑡𝑦 𝑟𝑎𝑡𝑒𝑖2 = 29.3
 ∑ 𝑦𝑖2 = 29.3
Variance of the explanatory variable in the model is 21.4.

∑(𝑥𝑖 −𝑥̅ )2
 𝜎𝑥2 = = 21.4
𝑛
 ∑(𝑥𝑖 − 𝑥̅ )2 = 𝑛𝜎𝑥2 = 10 ∗ 21.4 = 214
Moreover, the following value of the statistics can be used:

𝑡𝛼;(𝑛−2) = 𝑡0.05 = 2.306 ; 𝐹𝛼;(2−1);(𝑛−2) = 5.32.
2 ;(10−2)
2
b) Estimate a 95% confidence level for the slope of the model.
̂2 − 𝑡𝛼
𝛽 ̂2 ) ≤ 𝛽2 ≤ 𝛽
∗ 𝑠𝑒(𝛽 ̂2 + 𝑡𝛼 ̂2 )
∗ 𝑠𝑒(𝛽
;(𝑛−2) ;(𝑛−2)
2 2
𝜎̂𝜀 2
̂2 ) = √𝑣𝑎𝑟(𝛽
𝑠𝑒(𝛽 ̂2 ) = √
∑(𝑥𝑖 − 𝑥̅ )2
where:
𝑅𝑆𝑆 1.26
𝜎̂𝜀 2 = = = 0.1575
𝑛−2 8
And as explained above:
∑(𝑥𝑖 − 𝑥̅ )2 = 𝑛𝜎𝑥2 = 214
Thus , we have:
𝜎̂𝜀 2 0.1575
̂
𝑠𝑒(𝛽2 ) = √ = √ = 0.0271
∑(𝑥𝑖 − 𝑥̅ )2 214
The confidence interval will be:
−0.0688 − 2.306 ∗ 0.0271 ≤ 𝛽2 ≤ −0.0688 + 2.306 ∗ 0.0271
−0.1313 ≤ 𝛽2 ≤ −0.0063
Interpretation: in 95 out of 100 possible samples to be drawn from the population, the slope will
have values in the interval -0.1313 and -0.0063.
c) Test the significance of the two parameters for a 95% confidence level.
For individually testing the parameters we will use the t-statistic.
We will begin by testing the significance of the slope
4
 State the hypotheses
𝐻𝑜 : 𝛽2 = 0
𝐻1 : 𝛽2 ≠ 0
 Determine the critical value of the statistic

𝑡𝛼;(𝑛−2) = 𝑡0.05 = 2.306
2 ;(10−2)
2
 Calculate the statistic based on the data in the sample
̂2
𝛽 −0.0688
𝑡𝑐𝑎𝑙𝑐 = = = −2.538
𝑠𝑒(𝛽̂2 ) 0.0271
 Decision
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝛼;(𝑛−2) ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻𝑜 ⇒
2
The slope parameter (or the coefficient of the explanatory variable) is significantly different
from zero (or is statistically significant) with a confidence level of 95%.
Testing the significance of the intercept

𝐻𝑜 : 𝛽1 = 0
𝐻1 : 𝛽1 ≠ 0

𝑡𝛼;(𝑛−2) = 𝑡0.05 = 2.306
2 ;(10−2)
2
̂1
𝛽 2.8451
𝑡𝑐𝑎𝑙𝑐 = = = 5.8061
𝑠𝑒(𝛽̂1 ) 0.49
where the standard error of the intercept estimator was calculated as:
1 𝑥̅ 2 1 17.462
̂1 ) = √𝜎̂𝜀 2 ∗ [ +
𝑠𝑒(𝛽 ] = √0.1575 ∗ [ + ] = √0.2401 = 0.49
𝑛 ∑(𝑥𝑖 − 𝑥̅ )2 10 214
 Decision
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝑡𝑎𝑏 ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻𝑜 ⇒
The intercept of the model is significantly different from zero (or is statistically significant)
with a confidence level of 95%.
d) Fill in the ANOVA table.

Source of variation Degrees of freedom Sum of squares
Due to regression k−1=2−1=1 ESS = 1.01
Due to residuals n− k = 𝑛 − 2 = 8 RSS = 1.26 (calculated above)
Total 𝑛−1=9 TSS = 2.27
5
Where:
k = number of parameters in the model, including the intercept (k=2 for the simple regression model).
𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = ∑ 𝑦𝑖2 − 𝑛𝑦̅ 2 = 29.3 − 10 ∗ 1.64382 = 2.27
Since, from the proprieties of the regression line we have:

̂1 + 𝛽
𝑦̅ = 𝛽 ̂2 ∗ 𝑥̅ = 2.8451 − 0.0688 ∗ 17.46 = 1.6438
And it follows that:
𝐸𝑆𝑆 = 𝑇𝑆𝑆 − 𝑅𝑆𝑆 = 2.27 − 1.26 = 1.01
Alternatively, one can start from calculating ESS:
2
𝐸𝑆𝑆 = (𝛽̂2 ) ∗ ∑(𝑥𝑖 − 𝑥̅ )2 = (−0.0688)2 ∗ 214 = 1.01
And: 𝑇𝑆𝑆 = 𝐸𝑆𝑆 + 𝑅𝑆𝑆 = 1.01 + 1.26 = 2.27, thus reaching the same result.
e) Test the validity of the model using the statistic F (significance level 0.05).
𝐻𝑜 : 𝑚𝑜𝑑𝑒𝑙 𝑖𝑠 𝑛𝑜𝑡 𝑣𝑎𝑙𝑖𝑑 (𝛽2 = 0)
𝐻1 : 𝑚𝑜𝑑𝑒𝑙 𝑖𝑠 𝑣𝑎𝑙𝑖𝑑 (𝛽2 ≠ 0)

𝐹𝛼=0,05;(2−1);(𝑛−2) = 5.32
 Calculate the statistic F based on the data in the sample
𝐸𝑆𝑆/(2 − 1) 1.01
𝐹𝑐𝑎𝑙𝑐 = = = 6.41
𝑅𝑆𝑆/(𝑛 − 2) 1.26⁄8
Alternatively, the F statistic can be calculated as:
2
̂2
𝛽
𝐹𝑐𝑎𝑙𝑐 = ( ) = (−2.538)2 ≅ 6.4
𝑠𝑒(𝛽̂2 )
 Decision
𝐹𝑐𝑎𝑙𝑐 > 𝐹𝛼 ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻𝑜 ⇒
The regression model is valid with a confidence level of 95% (there is a significant relationship
between fertility rate and GDP/capita).

𝐸𝑆𝑆 1.01
𝑅2 = = = 0.445
𝑇𝑆𝑆 2.27
Interpretation: 44.5% of the total variation in the fertility rate (the dependent variable) can be
explained by the regression model (by the variation in the per capita income)
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g) Assuming a linear relationship between the two variables, calculate the coefficient of correlation
and test its significance for a 95% confidence level.
Assuming a linear relationship between the variables, for the simple regression model we have:
𝑟 2 = 𝑅 2 = 0.445 ⇒ |𝑟| = √0.445 = 0.667 ⇒ 𝑟 = −0.667
Since the coefficient of correlation has the same sign as the slope (inverse correlation).
Testing the coefficient of correlation:
𝐻𝑜 : 𝜌 = 0
𝐻1 : 𝜌 ≠ 0

𝑡𝛼;(𝑛−2) = 𝑡0.05 = 2.306
2 ;(10−2)
2
𝑟 −0.667
𝑡𝜌 = √𝑛 − 2 = √8 = −2.53
√1 − 𝑟 2 √1 − 0.445
 Decision
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝑡𝑎𝑏 ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻𝑜 ⇒
The coefficient of correlation is significantly different from zero  there is a significant
correlation between the two variables, with a confidence level of 95%.
h) Estimate a confidence interval for the fertility rate of a country with a GDP/capita of 15000 $.
̂1 + 𝛽
𝑥𝑝 = 15 ⇒ 𝑦̂𝑝 = 𝛽 ̂2 ∗ 𝑥𝑝 = 2.8451 − 0.0688 ∗ 15 = 1.8131
Confidence interval for 𝑦𝑝 :
𝑦
̂𝑝 − 𝑡𝛼;(𝑛−2) ∗ 𝑠𝑒(𝑦𝑝 − 𝑦
̂)
𝑝 ≤ 𝑦𝑝 ≤ 𝑦
̂𝑝 + 𝑡𝛼;(𝑛−2) ∗ 𝑠𝑒(𝑦𝑝 − 𝑦
̂)
𝑝
2 2
Where 𝑠𝑒(𝑦𝑝 − 𝑦
̂)
𝑝 is the forecast error calculated as follows:
1 (𝑥𝑝 − 𝑥̅ )2 1 (15 − 17.46)2

𝑠𝑒(𝑦𝑝 − 𝑦
̂) ̂𝜀 2 ∗ [1 +
𝑝 = √𝜎 + ] = √0.1575 ∗ [1 + + ] = 0.4215
𝑛 ∑(𝑥𝑖 − 𝑥̅ )2 10 214
Thus the confidence interval will be:
1.8131 − 2.306 ∗ 0.4215 ≤ 𝑦𝑝 ≤ 1.8131 + 2.306 ∗ 0.4215
0.841 ≤ 𝑦𝑝 ≤ 2.785
Interpretation: Based on the estimated model, one can infer that a country with a per capita GDP of
15000 $ will have a fertility rate between 0.84 and 2.78, with a confidence level of 95%.
7
Problem 2
For characterizing the economic potential of a region, data was recorded for 50 companies regarding
Turnover for 2016 (in mil lei) and number of employees in 2016. After processing the data, the following
results were obtained:
- The coefficient of variation for the No of employees is 15%;
- The coefficient of variation for Turnover is 20% ;
- Average Turnover for the companies in the sample was 10 mil lei;
- The correlation coefficient between the two variables was 0.8 (linear relationship holds);
- Standard deviation of the explanatory variable in the model is 1.215.
a) Estimate a regression model between the two variables and interpret the result from an
economic point of view.
b) Calculate and interpret the coefficient of determination.
c) Determine an estimate for the variance of the residuals. Calculate the standard error of the
regression.
Answers
a) Y = Turnover; X = Number of employees (based on economic logic).

𝜎𝑥 = 1.215; 𝑦̅ = 10; 𝑟 = 0.8.
𝜎𝑥 𝜎𝑥 𝜎𝑥 1.215
𝑐𝑣𝑥 = 15% ⇔ ∗ 100 = 15 ⇒ = 0.15 ⇒ 𝑥̅ = = = 8.1
𝑥̅ 𝑥̅ 0.15 0.15
𝜎𝑦 𝜎𝑦
𝑐𝑣𝑦 = 20% ⇔ ∗ 100 = 20 ⇒ = 0.2 ⇒ 𝜎𝑦 = 𝑦̅ ∗ 0.2 = 10 ∗ 0.2 = 2
𝑦̅ 𝑦̅
The data given in the problem suggest using the following formula to determine the slope estimator:
𝑐𝑜𝑣(𝑥, 𝑦) 𝑐𝑜𝑣(𝑥, 𝑦) 𝜎𝑦 𝜎𝑦 2
̂2 =
𝛽 = ∗ = 𝑟 ∗ = 0.8 ∗ = 1.317
𝜎𝑥2 𝜎𝑥 𝜎𝑦 𝜎𝑥 𝜎𝑥 1.215
̂1 = 𝑦̅ − 𝛽
𝛽 ̂2 ∗ 𝑥̅ = 10 − 1.317 ∗ 8.1 = −0.667
Economic interpretation: for every additional employee, the turnover increases with 1.317 thousand lei.
(1317 lei). As expected from economic theory, the relationship is positive between the two variables.
b) Considering the simple linear regression model , we have that:

𝑅 2 = 𝑟 2 ⇒ 𝑅 2 = 0.82 = 0.64
64% in the total variation of the turnover can be explained by the regression model (by the variation
in the number of employees).
𝐸𝑆𝑆 𝑇𝑆𝑆−𝑅𝑆𝑆 𝑅𝑆𝑆 𝑅𝑆𝑆

c) 𝑅 2 = 𝑇𝑆𝑆 = = 1 − 𝑇𝑆𝑆 = 0.64 ⇒ 𝑇𝑆𝑆 = 0.36
𝑇𝑆𝑆
𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = 𝑛𝜎𝑦2 = 50 ∗ 22 = 200
From the two relationships above: 𝑅𝑆𝑆 = 𝑇𝑆𝑆 ∗ 0.36 = 200 ∗ 0.36 = 72
8
An estimate for the variance of the residuals is:
𝑅𝑆𝑆 72
𝜎̂𝜀2 = = = 1.5
𝑛 − 2 48
The standard error of the regression model is determined as:
𝑅𝑆𝑆
𝑆𝐸 𝑜𝑓 𝑅𝑒𝑔𝑟𝑒𝑠𝑠𝑖𝑜𝑛 = √ = √1.5 = 1.22
𝑛−2
Problem 3
A sample of 15 bank agencies was used to estimate the relationship between the number of credit cards
issued in a quarter and the quarterly profit of the agency (expressed in thousand lei). The following model
is to be estimated:
𝑃𝑟𝑜𝑓𝑖𝑡 = 𝛽1 + 𝛽2 ∗ 𝑁𝑜 𝐶𝑟𝑒𝑑𝑖𝑡 𝐶𝑎𝑟𝑑𝑠 + 𝜀

 The standard deviation of the explanatory variable is 0.44, while the average of the explanatory
variable is 4.3.
 ∑15 15 2 15
𝑖=1 𝑃𝑟𝑜𝑓𝑖𝑡𝑖 ∗ 𝑁𝑜𝐶𝑟𝑒𝑑𝑖𝑡𝐶𝑎𝑟𝑑𝑠𝑖 = 4665; ∑𝑖=1 𝑃𝑟𝑜𝑓𝑖𝑡𝑖 = 78255; ∑𝑖=1 𝑃𝑟𝑜𝑓𝑖𝑡𝑖 = 1078.5 .
Requests
a) Estimate the parameters of the model and interpret the results.
c) Test the validity of the model for 0.05 level of significance.
The critical values of the statistics are: 𝑡𝛼;(𝑛−2) = 2.16; 𝐹𝛼;(2−1);(𝑛−2) = 4.67
2
Answers
a) Estimate the parameters of the model and interpret the results.
Y (dependent variable) = Profit; X (explanatory variable) = No of credit cards.

The data given in the problem can be summarized as follows:
∑ 𝑥𝑖 𝑦𝑖 = 4665; ∑ 𝑦𝑖2 = 78255; ∑ 𝑦𝑖 = 1078.5 ; 𝜎𝑥 = 0.44; 𝑥̅ = 4.3; 𝑛 = 15

∑ 𝑦𝑖 1078.5
̅𝑦 = = = 71.9
𝑛 15
𝑛 ∑ 𝑥𝑖 𝑦𝑖 − ∑ 𝑥𝑖 ∑ 𝑦𝑖 𝑐𝑜𝑣(𝑥, 𝑦) 1.83
̂𝟐 =
𝛽 = = = 9.45
2 2
𝜎𝑥 (0.44)2
𝑛 ∑ 𝑥𝑖2 − (∑ 𝑥𝑖 )
∑ 𝑥𝑖 𝑦𝑖 4665
𝑐𝑜𝑣(𝑥, 𝑦) = − 𝑥̅ 𝑦̅ = − 4.3 ∗ 71.9 = 1.83
𝑛 15
9
(or the first formula could be equally used to find the slope estimator)
̂𝟏 = 𝑦̅ − 𝛽
𝛽 ̂𝟐 ∗ 𝑥̅ = 71.9 − 9.45 ∗ 4.3 = 31.26
For an additional credit card issued, the quarterly profit will increase with 9.45 thousand lei (9450 lei).
𝐸𝑆𝑆 259.33
𝑅2 = = = 0.3648
𝑇𝑆𝑆 710.85
𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = ∑ 𝑦𝑖2 − 𝑛𝑦̅ 2 = 78255 − 15 ∗ 71.92 = 710.85
2
𝐸𝑆𝑆 = (𝛽̂2 ) ∗ ∑(𝑥𝑖 − 𝑥̅ )2 = 9.452 ∗ 15 ∗ (0.44)2 = 259.33
Interpretation: 36% of the total variation in the quarterly profit of the agencies can be explained
by the regression model (by the variation of the number of credit cards issued).
c) Test the validity of the model for a 0.05 level of significance.

𝐻𝑜 : 𝑚𝑜𝑑𝑒𝑙 𝑖𝑠 𝑛𝑜𝑡 𝑣𝑎𝑙𝑖𝑑 (𝛽2 = 0)
𝐻1 : 𝑚𝑜𝑑𝑒𝑙 𝑖𝑠 𝑣𝑎𝑙𝑖𝑑 (𝛽2 ≠ 0)

𝐹𝛼;(2−1);(𝑛−2) = 4.67.
 Calculate the statistic F based on the data in the sample
𝑅2 0.3648
𝐹𝑐𝑎𝑙𝑐 = 2
∗ (𝑛 − 2) = ∗ 13 = 7.46
1−𝑅 1 − 0.3648
Alternatively, the F statistic can be calculated as:
𝐸𝑆𝑆/(2 − 1) 259.33
𝐹𝑐𝑎𝑙𝑐 = = = 7.46
𝑅𝑆𝑆/(𝑛 − 2) 451.52/13
𝑤ℎ𝑒𝑟𝑒 𝑅𝑆𝑆 = 𝑇𝑆𝑆 − 𝐸𝑆𝑆 = 710.85 − 259.33 = 451.52
 Decision
𝐹𝑐𝑎𝑙𝑐 > 𝐹𝑡𝑎𝑏 ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻𝑜 ⇒
The regression model is valid with a confidence level of 95%.
10
Problem 4
A sample of 10 countries is considered to study the dependence between GDP (in billion EUR) and
Investments (billion EUR). The following equation was obtained after estimating the model:
𝐺𝐷𝑃 = 𝑎 + 3.86 ∗ 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 + 𝜀̂
The estimated residuals associated with the model are:
-20.78 ; 11.49; 36.04; 26.74; -37.82; -31.68; -3.47; -0.78; 6.49; 13.77.
The average value of the GDP for the countries in the sample is 205.5 billion EUR; the total value of
the investments for the countries in the sample is 164 billion EUR. The standard deviation of the
dependent variable in the model is 34.82 billion EUR.
a) Determine the value “a” in the estimated model.
b) Interpret the slope of the model from an economic point of view.
c) If the variance of the slope estimator in the model is 1.4271, test the significance of the slope for
a 5% level of significance (the critical value of the statistic is 2.3).
d) Build a 95% confidence interval for the parameter of the explanatory variable. Interpret the result.
e) Test the overall significance of the model using F test (for a 0.05 significance level, the critical
value of the F statistic is 5.3).
g) Determine a 95% confidence interval for the GDP if the Investments are 17 billion EUR.
Answers:
𝑛 = 10; 𝑦̅ = 205.5; ∑ 𝑥𝑖 = 164; 𝜎𝑦 = 34.82
a) 𝑎 = 𝑦̅ − 3.86 ∗ 𝑥̅ = 205.5 − 3.86 ∗ 16.4 = 142.2

b) For an increase in Investments with 1 billion EUR, the GDP will increase by 3.86 bill EUR.
3,86
c) 𝑡𝑐𝑎𝑙𝑐 = = 3.23 > 2.3 ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻0 , the slope is statistically significant for a 95%
√1.4271
confidence level.
d) 3.86 − 2.3 ∗ √1.4271 ≤ 𝛽2 ≤ 3.86 + 2.3 ∗ √1.4271 ⇔ 1.11 ≤ 𝛽2 ≤ 6.61
e) 𝑅𝑆𝑆 = (−20.78)2 + ⋯ + (13.77)2 = 5256
𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = 𝑛𝜎𝑦2 = 10 ∗ 34.822 = 12124.3
𝐸𝑆𝑆 = 𝑇𝑆𝑆 − 𝑅𝑆𝑆 = 6868.3
𝐸𝑆𝑆/(2−1) 6868.3
𝐹𝑐𝑎𝑙𝑐 = 𝑅𝑆𝑆/(𝑛−2) = 5256/8 = 10.4 > 5.3 ⇒ 𝑟𝑒𝑗𝑒𝑐𝑡 𝐻𝑜 (𝐻𝑜 :model is not valid)  the regression
model is valid with a 95% confidence.
𝐸𝑆𝑆
f) 𝑅 2 = 𝑇𝑆𝑆 = 0.56
56% of the total variation in the dependent variable (GDP) is explained by the regression model.
g) 𝑥𝑝 = 17 ⇒ 𝑦̂𝑝 = 142.2 + 3.86 ∗ 17 = 207.82
2 1 (𝑥𝑝 − 𝑥̅ )2 1 (17 − 16.4)2

𝑠𝑒(𝑦𝑝 − 𝑦𝑝 = √𝜎
̂) ̂𝜀 ∗ [1 + + ] = √657 ∗ [1 + + ] = 26.89
𝑛 ∑(𝑥𝑖 − 𝑥̅ )2 10 460,4
2 5256 2 𝜎̂𝜀 2 2
𝜎̂𝜀 2 657
𝜎̂𝜀 = = 657; 𝜎̂𝛽̂2 = 2
⇒ ∑(𝑥𝑖 − 𝑥̅ ) = 2 = = 460.4
8 ∑(𝑥𝑖 − 𝑥̅ ) 𝜎̂𝛽̂2 1,4271
207.82 − 2.3 ∗ 26.89 ≤ 𝑦𝑝 ≤ 207.82 + 2.3 ∗ 26.89 ⇒ 145.97 ≤ 𝑦𝑝 ≤ 269.67
11
B. Multiple regression model
References: Lectures 6 and 7

Seminars 6 and 7
Gujarati book: chapters 7 (please refer also to Appendix C for the matrix approach) and
chapter 8.
Main contents:
 The matrix approach of the linear regression model
o Estimating the parameters using the matrix approach
o Variance – covariance matrix of the estimates
 Economic interpretation of the estimates
 Testing the significance of the parameters (t-test)
 Confidence intervals for the parameters
 ANOVA
 F- test – testing the validity of the model
 Coefficient of determination, Adjusted coefficient of determination
 Forecasting
For part B please find below two solved problems.
Problem 5
For a regression model with two explanatory variables and intercept, the following are given:
10 78 42 1.3186 −0.07321 −0.15417 2195

𝑋𝑇 𝑋 = ( 752 310 ) , (𝑋 𝑇
𝑋) −1
= ( 0.007413 0.003665 ) , 𝑋 𝑇
𝑌 = ( 16160).
212 0.0299 9685
The variance of the dependent variable in the model is 1067.3 and the residual sum of squares is 403.7
Requests:
a) Calculate the average of the dependent variable.

b) Estimate the parameters of the model. Interpret the results from an economic point of view.
c) Determine the variance-covariance matrix of the parameters.
d) Which of the coefficients are individually statistically significant at the 5 percent level? (use the
critical value of the statistic 2.365)
e) Calculate, interpret and compare the coefficient of determination and the adjusted coefficient of
determination.
f) What is the overall significance of the regression? (use the critical value of the statistic 4.74)
g) Assuming that for the explanatory variables the values 12 and 7 are set, forecast the value of the
dependent variable for a 95% confidence level.
12
Solution
a) From the general form of the 𝑋 𝑇 𝑋 matrix, n = 10, while from the general form of the 𝑋 𝑇 𝑌 vector,
we identify: ∑ 𝑦𝑖 = 2195.
∑ 𝑦𝑖 2195
Thus, we obtain: 𝑦̅ = = = 219.5
𝑛 10
b) The regression model is : 𝑦 = 𝛽1 + 𝛽2 ∗ 𝑋2 + 𝛽3 ∗ 𝑋3 + 𝜀
We estimate the parameters using the following formula:
𝛽̂ = (𝑋 𝑇 𝑋)−1 𝑋 𝑇 𝑌
1.3186 −0.07321 −0.15417 2195 218.12 ̂1

𝛽
𝛽̂ = (𝑋 𝑇 𝑋)−1 𝑋 𝑇 𝑌 = (−0.07321 0.007413 ̂2 )
0.003665 ) (16160) ≅ ( −5.41 ) = (𝛽
−0.15417 0.003665 0.0299 9685 10.4 ̂3
𝛽
Matrix 𝑋 𝑇 𝑋 and (𝑋 𝑇 𝑋)−1 are symmetrical (!)
The estimated regression model will then be: 𝑦̂ = 218.12 − 5.41 ∗ 𝑋2 + 10.4 ∗ 𝑋3
Economic interpretation of the coefficients:
 Holding all other variables constant, for an increase in variable 𝑋2 with one unit, the dependent
variable will decrease by 5.14 units
 An increase in variable 𝑋3 by one unit determines an increase of 10.4 units in variable Y, holding
all other variables constant.
c) An estimator of the variance – covariance matrix of the parameters is:
̂̂ )
𝑣𝑎𝑟(𝛽 ̂ ̂
̂1 , 𝛽̂2 ) 𝑐𝑜𝑣(𝛽
𝑐𝑜𝑣(𝛽 ̂1 , 𝛽̂3 )
1
̂ ̂ ) = 𝜎̂ 2 (𝑋 𝑇 𝑋)−1
𝑣𝑎𝑟 − 𝑐𝑜𝑣𝑎𝑟(𝛽 ̂̂2 , 𝛽̂1 )
= (𝑐𝑜𝑣(𝛽 ̂2 ) ̂̂2 , 𝛽̂3 ))
𝜀 𝑣𝑎𝑟(𝛽 𝑐𝑜𝑣(𝛽
̂ ̂
̂3 , 𝛽̂1 ) 𝑐𝑜𝑣(𝛽
𝑐𝑜𝑣(𝛽 ̂3 , 𝛽̂2 ) ̂̂ )
𝑣𝑎𝑟(𝛽 3
Where:
𝑅𝑆𝑆 403.7
𝜎̂𝜀2 = = = 57.67
𝑛−3 7
1.3186 −0.07321 −0.15417 76.0437 −4.222 −8.891
̂̂ ) = 57.67 ∗ (
𝑣𝑎𝑟 − 𝑐𝑜𝑣𝑎𝑟(𝛽 0.007413 0.003665 ) = ( 0.4275 0.2114 )
0.0299 1.7243
The variances of the estimators are to be found on the main diagonal of the variance-covariance matrix
̂̂ ) = 76.437; 𝑣𝑎𝑟(𝛽
above: 𝑣𝑎𝑟(𝛽 ̂̂ ) = 0.4275; 𝑣𝑎𝑟(𝛽 ̂̂ ) = 1.7243
1 2 3
13
d)
𝐻𝑜 : 𝛽1 = 0
𝐻1 : 𝛽1 ≠ 0
̂1
𝛽 218.12
𝑡𝑐𝑎𝑙𝑐 = = = 25
̂̂ ) √76.0437
√𝑣𝑎𝑟(𝛽1
𝑡𝑡𝑎𝑏 = 2.365
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝑡𝑎𝑏 ⇒ reject 𝐻𝑜 , the intercept is statistically significant with a 95% confidence level.
𝐻𝑜 : 𝛽2 = 0
𝐻1 : 𝛽2 ≠ 0
5.41
𝑡𝑐𝑎𝑙𝑐 = − = −8.27
√0.4275
𝑡𝑡𝑎𝑏 = 2.365
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝑡𝑎𝑏 ⇒ reject 𝐻𝑜 , the coefficient of 𝑋2 variable is statistically significant with a 95% confidence
level.
𝐻𝑜 : 𝛽3 = 0
𝐻1 : 𝛽3 ≠ 0
10.4
𝑡𝑐𝑎𝑙𝑐 = = 7.92
√1.7243
𝑡𝑡𝑎𝑏 = 2.365
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝑡𝑎𝑏 ⇒ reject 𝐻𝑜 , the coefficient of 𝑋3 variable is statistically significant with a 95% confidence
level.
14
e)
𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = 𝑛𝜎2𝑦 = 10 ∗ 1067.3 = 10673
𝑅𝑆𝑆 = 403.7
𝐸𝑆𝑆 = 𝑇𝑆𝑆 − 𝑅𝑆𝑆 = 10673 − 403.7 = 10269.3
The coefficient of determination will be:

𝐸𝑆𝑆 10269.3
𝑅2 = = = 0.9621
𝑇𝑆𝑆 10673
96% of the total variation in the dependent variable is explained by the regression model.
The adjusted coefficient of determination is calculated as:

𝑅𝑆𝑆 403.7
̅ 2
𝑅 =1− 𝑛 − 3 = 1 − 7 = 0.95
𝑇𝑆𝑆 10673
𝑛−1 9
f) Testing the overall significance of the model (the validity of the model)
𝐻𝑜 : 𝛽2 = 𝛽3 = 0 (the regression model is not valid)
𝐻1 : (∃) 𝛽𝑖 ≠ 0
𝐸𝑆𝑆/(3 − 1) 10269.3/2
𝐹𝑐𝑎𝑙𝑐 = = = 89
𝑅𝑆𝑆/(𝑛 − 3) 403.7/7
𝐹𝑡𝑎𝑏 = 4.74
𝐹𝑐𝑎𝑙𝑐 > 𝐹𝑡𝑎𝑏 ⇒ reject 𝐻𝑜 , the model is valid with a 95% confidence level.
g) Assuming that for the explanatory variables the values 12 and 7 are set, forecast the value of the
dependent variable for a 95% confidence level.
𝑥2 𝑝 = 12; 𝑥3 𝑝 = 7
𝑦
̂𝑝 = 218.12 − 5.41 ∗ 12 + 10.4 ∗ 7 = 226
The vector 𝑥𝑝 = (1 12 7)
The confidence interval for the dependent variable is: 𝑦

̂𝑝 − 𝛥 ≤ 𝑦𝑝 ≤ 𝑦
̂𝑝 + 𝛥
15
where
𝛥 = 𝑡𝛼;(𝑛−3) ∗ 𝜎̂𝜀 ∗ √1 + 𝑥𝑝 (𝑋 𝑇 𝑋)−1 𝑥𝑝𝑇

2
1.3186 −0.07321 −0.15417 1

𝑥𝑝 (𝑋 𝑇 𝑋)−1 𝑥𝑝𝑇 = (1 12 7) (−0.07321 0.007413 0.003665 ) (12)
−0.15417 0.003665 0.0299 7
1
= (−0.6391 0.00414 0.0991) (12) = 0.1043
7
We have already calculated:
𝑅𝑆𝑆 403.7
𝜎̂𝜀2 = = = 57.67
𝑛−3 7
Thus, we obtain:
𝛥 = 2.365 ∗ √57.67 ∗ √1 + 0.1043 = 18.87
And the interval will be:
226 − 18.87 ≤ 𝑦𝑝 ≤ 226 + 18.87 ⇔ 207.13 ≤ 𝑦𝑝 ≤ 244.87
Problem 6
The following regression model was estimated on a sample of 40 observations:
𝑦𝑖 = 3.7 + 2.45 ∗ 𝑋2𝑖 + 1.3 ∗ 𝑋3𝑖 − 0.59 ∗ 𝑋4𝑖 + 𝜀̂𝑖

(1.21) (0.78) (0.92) (0.12)
In parenthesis, under each estimator are the standard errors of the coefficients.
We also know: the coefficient of determination 0.76; an estimator for the variance of the residuals is 0.861.
a) Test the validity of the model.

b) Fill in the ANOVA table of this model.
c) Test the significance of the coefficients associated with variables 𝑋3 and 𝑋4.
d) Is the intercept of the model significantly different from 2?
e) Calculate the variance of the dependent variable.
16
Solution
a) n = 40; k = number of parameters in the regression model = 4.
𝐻𝑜 : 𝛽2 = 𝛽3 = 𝛽4 = 0 (the regression model is not valid)

𝐻1 : (∃) 𝛽𝑖 ≠ 0
𝑅2 𝑛−𝑘 0.76 40 − 4
𝐹𝑐𝑎𝑙𝑐 = 2
∗ = ∗ = 38
1 − 𝑅 𝑘 − 1 1 − 0.76 4 − 1
𝐹𝑡𝑎𝑏 = 𝐹𝛼;(4−1);(𝑛−4) = 2.87
𝐹𝑐𝑎𝑙𝑐 > 𝐹𝑡𝑎𝑏 ⇒ reject 𝐻𝑜 the regression model is valid with a 95% confidence level.
b)
𝑅𝑆𝑆
𝜎̂𝜀2 = = 0.861 ⇒ 𝑅𝑆𝑆 = 0.861 ∗ 36 = 31
𝑛−4
𝐸𝑆𝑆 𝑅𝑆𝑆 𝑅𝑆𝑆 31
𝑅2 = = 1− = 0.76 ⇒ = 0.24 ⇒ 𝑇𝑆𝑆 = = 129.17
𝑇𝑆𝑆 𝑇𝑆𝑆 𝑇𝑆𝑆 0.24
The ANOVA Table:
Source of variation Sum of squares Degrees of freedom
Due to regression ESS = 129.17 – 31 = 98.17 k–1=4–1=3
Due to residuals RSS = 31 n – k = 40 – 4 = 36
Total TSS = 129.17 n – 1 = 40 – 1 = 39
c)
𝐻𝑜 : 𝛽3 = 0
𝐻1 : 𝛽3 ≠ 0
̂3
𝛽 1.3
𝑡𝑐𝑎𝑙𝑐 = = = 1.41
̂3 ) 0.92
𝑠𝑒(𝛽
𝑡𝛼;(𝑛−4) = 2
2
|𝑡𝑐𝑎𝑙𝑐 | < 𝑡𝑡𝑎𝑏 ⇒ do not reject 𝐻𝑜 , the coefficient of variable 𝑋3 is not statistically significant at a 5%
significance level, thus the variable 𝑋3 is not an influence factor correctly specified for Y.
17
𝐻𝑜 : 𝛽4 = 0
𝐻1 : 𝛽4 ≠ 0
̂4
𝛽 −0.59
𝑡𝑐𝑎𝑙𝑐 = = = −4.92
̂4 )
𝑠𝑒(𝛽 0.12
𝑡𝑡𝑎𝑏 = 2
|𝑡𝑐𝑎𝑙𝑐 | > 𝑡𝑡𝑎𝑏 ⇒ reject 𝐻𝑜 , the coefficient of variable 𝑋4 is statistically significant with a 95% confidence.
d)
𝐻𝑜 : 𝛽1 = 2
𝐻1 : 𝛽1 ≠ 2
̂1 − 2 3.7 − 2
𝛽
𝑡𝑐𝑎𝑙𝑐 = = = 1.4
̂1 )
𝑠𝑒(𝛽 1.21
𝑡𝑡𝑎𝑏 = 2
|𝑡𝑐𝑎𝑙𝑐 | < 𝑡𝑡𝑎𝑏 ⇒ do not reject 𝐻𝑜 , the intercept is not significantly different from 2, for a 95% confidence
level.
e)
∑(𝑦𝑖 − 𝑦̅)2 𝑇𝑆𝑆 129.17

𝜎𝑦2 = = = = 3.23
𝑛 𝑛 40
18
C. Assumptions of the CLRM
 Multicollinearity: Lecture 8, Seminar 8 (Gujarati: Chapter 10)

 Heteroscedasticity: Lecture 9, Seminar 9 (Gujarati: Chapter 11)
 Autocorrelation: Lecture 10, Seminar 9 (Gujarati, Chapter 12)
For each of the assumptions refer to:
 Defining the assumption of the regression model, causes / sources;

 Consequences on the regression model if the assumption does not hold;
 Detection (tests);
 Possible remedial measures.
D. EVIEWS
EVIEWS interpretation of a regression model output:

 Write the equation of the estimated regression model from an EViews output
 Economic interpretation of the coefficients
 Statistical significance of the parameters and validity of the model
 Interpretation of the coefficient of determination
Reference: seminars in Eviews, all along the semester
You can also use the assignments in your project.
EVIEWS interpretation of a regression model test output:
 Identify the assumption of the CLRM which is being tested.

 Write the general form of the auxiliary regression that is estimated in the test (if the case)
 State the null and the alternative hypothesis of the test.
 Determine the conclusion of the test and if the assumption stated initially holds.
Eviews outputs interpretation include (and not limited to):

o White, Glesjer, Breusch Pagan tests to detect heteroscedasticty;
o Breusch Godfrey test to detect if the residuals are autocorrelated or not;
o Calculation, interpretation of the Durbin Watson statistic;
o Jarque Bera test to detect if the residuals follow a normal distribution;
o Multicollinearity detection : Klein’s rule of thumb; VIF; etc.
You can also use as reference the second assignment from your project – request 5.
19
E. Simultaneous equations models (SEM)
References: Lecture 11 (see the PPT material).

Seminar 12
Gujarati book: Chapters 18, 19, 20.
Main contents:
 Nature of SEM
 Reduced form of SEM
 The simultaneous –equation bias
 Rules for identification
 Estimation of SEM
For part E please find below a solved problem.
Problem 7.
Consider the following model:
𝑅𝑡 = 𝑎 + 𝑏𝑌𝑡 + 𝑐𝑀𝑡−1 + 𝑢𝑡
{
𝑌𝑡 = 𝑑 + 𝑒𝑅𝑡 + 𝑓𝐼𝑡 + 𝑣𝑡
Where: 𝑀 is the money supply, 𝑅 is the interest rate, 𝑌 is the GDP and I the investments.
The endogenous variables of the model are: 𝑅𝑡 , 𝑌𝑡
The predetermined variables are: 𝑀𝑡−1 , 𝐼𝑡 .
We also know that: 𝑐𝑜𝑣(𝑀𝑡−1 , 𝑢𝑡 ) = 𝑐𝑜𝑣(𝑀𝑡−1 , 𝑣𝑡 ) = 0, 𝑐𝑜𝑣(𝐼𝑡 , 𝑢𝑡 ) = 𝑐𝑜𝑣(𝐼𝑡 , 𝑣𝑡 ) = 0,
𝐸 (𝑢𝑡2 ) = 𝜎𝑢2 ; 𝐸 (𝑣𝑡2 ) = 𝜎𝑣2 ; 𝐸(𝑢𝑡 ) = 𝐸(𝑣𝑡 ) = 0; 𝑐𝑜𝑣(𝑢𝑡 ; 𝑣𝑡 ) = 0
a) Obtain the reduced-form equations.

b) Are the equations identified?
c) For the identified equations, does OLS provide good estimates for the parameters? (think of the
specification bias usually encountered in SEM)
20
Solution
a) Substitute equation (2) in equation (1):
𝑅𝑡 = 𝑎 + 𝑏(𝑑 + 𝑒𝑅𝑡 + 𝑓𝐼𝑡 + 𝑣𝑡 ) + 𝑐𝑀𝑡−1 + 𝑢𝑡
𝑅𝑡 = 𝑎 + 𝑏𝑑 + 𝑏𝑒𝑅𝑡 + 𝑏𝑓𝐼𝑡 + 𝑏𝑣𝑡 + 𝑐𝑀𝑡−1 + 𝑢𝑡
𝑅𝑡 − 𝑏𝑒𝑅𝑡 = 𝑎 + 𝑏𝑑 + 𝑏𝑓𝐼𝑡 + 𝑐𝑀𝑡−1 + 𝑏𝑣𝑡 + 𝑢𝑡
𝑎 + 𝑏𝑑 𝑏𝑓 𝑐 𝑏𝑣𝑡 + 𝑢𝑡
𝑅𝑡 = + 𝐼𝑡 + 𝑀𝑡−1 + (1 ∗)
1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒
Substitute equation (1) in equation (2):
𝑌𝑡 = 𝑑 + 𝑒𝑅𝑡 + 𝑓𝐼𝑡 + 𝑣𝑡
𝑌𝑡 = 𝑑 + 𝑒(𝑎 + 𝑏𝑌𝑡 + 𝑐𝑀𝑡−1 + 𝑢𝑡 ) + 𝑓𝐼𝑡 + 𝑣𝑡
𝑌𝑡 − 𝑏𝑒𝑌𝑡 = 𝑑 + 𝑎𝑒 + 𝑒𝑐𝑀𝑡−1 + 𝑒𝑢𝑡 + 𝑓𝐼𝑡 + 𝑣𝑡
𝑑 + 𝑎𝑒 𝑒𝑐 𝑓 𝑒𝑢𝑡 + 𝑣𝑡
𝑌𝑡 = + 𝑀𝑡−1 + 𝐼𝑡 + (2 ∗)
1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒
Equations (1*) and (2*) represent the reduced form of the SEM.
b)
The number of endogenous variables in the model: G = 2
The number of predetermined (exogenous) variables in the model: K=2
Equation 1:
g’ = 2 (number of endogenous variables in the first equation)
k’ = 1 (number of predetermined variables in the first equation)
𝐾 − 𝑘′ = 𝑔′ − 1 (2 – 1 = 2 – 1), thus the first equation is exactly identified.
Equation 2:
g’’ = 2 (number of endogenous variables in the second equation)
k’’ = 1 (number of predetermined variables in the second equation)
𝐾 − 𝑘′’ = 𝑔′’ − 1 (2 – 1 = 2 – 1), thus the second equation is exactly identified.
21
c)
A unique feature of SEM is that the endogenous variable in one equation may appear as an explanatory
variable in another equation of the system. In this SEM, both 𝑅𝑡 and 𝑌𝑡 (the endogenous variables) appear
as explanatory variables in the other equations.
Usually such endogenous explanatory variables are correlated with the disturbance term of the equation
in which it appears as explanatory variable. Thus, we will evaluate the following:
𝑐𝑜𝑣 (𝑌𝑡 , 𝑢𝑡 ) and 𝑐𝑜𝑣 (𝑅𝑡 , 𝑣𝑡 )
For calculating 𝑐𝑜𝑣 (𝑌𝑡 , 𝑢𝑡 ), we substitute 𝑌𝑡 with equation (2*):
𝑑 + 𝑎𝑒 𝑒𝑐 𝑓 𝑒𝑢𝑡 + 𝑣𝑡
𝑐𝑜𝑣 (𝑌𝑡 , 𝑢𝑡 ) = 𝑐𝑜𝑣 ( + 𝑀𝑡−1 + 𝐼𝑡 + , 𝑢𝑡 )
1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒
𝑑 + 𝑎𝑒 𝑒𝑐 𝑓
= 𝑐𝑜𝑣 ( , 𝑢𝑡 ) + 𝑐𝑜𝑣 ( 𝑀𝑡−1 , 𝑢𝑡 ) + 𝑐𝑜𝑣 ( 𝐼 ,𝑢 )
1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒 𝑡 𝑡
𝑒𝑢𝑡 + 𝑣𝑡 𝑒 1
+ 𝑐𝑜𝑣 ( , 𝑢𝑡 ) = 0 + 0 + 0 + 𝑐𝑜𝑣(𝑢𝑡 , 𝑢𝑡 ) + 𝑐𝑜𝑣(𝑣𝑡 , 𝑢𝑡 )
1 − 𝑏𝑒 1 − 𝑏𝑒 1 − 𝑏𝑒
𝑒
= 𝜎 2 ≠ 0.
1 − 𝑏𝑒 𝑢
In the expression above we used the assumptions from the beginning of the problem.
Thus, for the first equation of SEM the classical OLS method may not be applied to estimate the
parameters since the explanatory variable of the equation (𝑌𝑡 ) is correlated with the disturbance term in
that equation (𝑢𝑡 ); the estimators thus obtained would be inconsistent.
In a similar manner we will obtain:
𝑏
𝑐𝑜𝑣(𝑅𝑡 , 𝑣𝑡 ) = 𝜎2 ≠ 0
1 − 𝑏𝑒 𝑣
For the second equation of SEM we cannot apply the classical OLS (same explanation as above).
22
F. Time Series
References: Lecture 12, 13, 14.

Seminar 13.
Gujarati book: Chapters 21, 22.
Main contents:
 Stationary vs. non-stationary time series
 Defining a stationary time series
 Random walk models
 White noise models
 Correlogram of a time series (patterns of a stationary vs. a non-stationary series)
 Testing the stationarity: the unit-root tests (Dickey fuller tests)
 How to transform a non-stationary time series
 Integration order
 Box Jenkins methodology – main steps
 General forms of an AR(p) and a MA(q) process
 EVIEWS (refer to Seminar 13):
o Interpret the result of a unit root test (Augmented Dickey Fuller)
o Identify the correlogram pattern of a stationary/ non-stationary series.
23
After solving on your own (using the solution just for checking your results!) the problems above
you can further exercise with the following 
Problem 8
A sample of 12 real-estate agents is considered to study the dependence between the monthly sales of
apartments (in number of apartments) and the agents’ experience (in years). The following equation was
obtained after estimating the model:
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑎𝑝𝑎𝑟𝑡𝑎𝑚𝑒𝑛𝑡𝑠 = 2.2 + 0.2 ∗ 𝐸𝑥𝑝𝑒𝑟𝑖𝑒𝑛𝑐𝑒 + 𝜀̂
On average, a real estate agent from the sample has an experience of 26 years; the standard deviation of
the dependent variable in the model is 3.
The estimated residuals associated with the model are:
-0,06; 2,09; 1,65; 2,09; -0,55; 0,6; 1; -0,3; -0,27; -3,1; -3,38; 0,23.
a) Based on the estimated model, how many additional years of experience does an agent need in
order to sell one more apartment per month?
b) What is the average number of apartments sold monthly by the agents in the sample?
c) If the standard error of the slope coefficient in the model is 0,041, test the significance of the slope
for a 5% level of significance (the critical value of the statistic is 2.2).
d) Build a 95% confidence interval for the parameter of the explanatory variable. Interpret the result.
e) Test the overall significance of the model using F test (for a 0.05 significance level, the critical
value of the F statistic is 4.96).
g) Starting from the estimated regression model, determine a 95% confidence interval for the number
of apartments sold / month by a real-estate agent with 25 years of experience.
Problem 9
For a sample of companies the following model is estimated:

𝑦 = 11.3 + 𝑘 ∗ 𝑋2 + 1.1 ∗ 𝑋3 + 𝜀̂
Where: Y = the profit (thousand Euro); X2 = number of competitors; X3 = Advertising expenses (thousand
Euro).
The following are also given:
12 50 100 0.493 −0.066 176
𝑋𝑡 𝑋 = ( 254 488 ) ; (𝑋 𝑡
𝑋) −1
= ( 0.0434 −0.0138 ) ; 𝑋 𝑡
𝑌 = ( 750 )
1058 −0.016 0.0088 1622
The sum of the squared residuals is 75 and ∑ 𝑦𝑖2 = 2810.

a) How many companies were included in the sample?
b) Determine the value k.
c) Interpret the coefficient of variable X3 from an economic point of view.
d) Test the significance of the coefficient associated with the variable X3, for a 5% level of
significance (the critical value of the statistic is 2.26).
e) Test the overall significance of the model (for a 0.05 significance level, the critical value of the
statistic is 4.25).
24

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Econometrics – Revision Guideline (January 2018)

A. Simple Regression Model

A. Simple regression model

The following are also given:

a) Interpret the estimates from an economic point of view.

Considering the data given in the problem we have:

A sample of 10 countries is chosen

Variance of the explanatory variable in the model is 21.4.

 ∑(𝑥𝑖 − 𝑥̅ )2 = 𝑛𝜎𝑥2 = 10 ∗ 21.4 = 214

Moreover, the following value of the statistics can be used:

b) Estimate a 95% confidence level for the slope of the model.

−0.0688 − 2.306 ∗ 0.0271 ≤ 𝛽2 ≤ −0.0688 + 2.306 ∗ 0.0271

 Determine the critical value of the statistic

Testing the significance of the intercept

 State the hypotheses

 Determine the critical value of the statistic

d) Fill in the ANOVA table.

𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = ∑ 𝑦𝑖2 − 𝑛𝑦̅ 2 = 29.3 − 10 ∗ 1.64382 = 2.27

Since, from the proprieties of the regression line we have:

 Determine the critical value of the statistic

f) Calculate and interpret the coefficient of determination.

 Determine the critical value of the statistic

Confidence interval for 𝑦𝑝 :

1 (𝑥𝑝 − 𝑥̅ )2 1 (15 − 17.46)2

Thus the confidence interval will be:

1.8131 − 2.306 ∗ 0.4215 ≤ 𝑦𝑝 ≤ 1.8131 + 2.306 ∗ 0.4215

a) Y = Turnover; X = Number of employees (based on economic logic).

b) Considering the simple linear regression model , we have that:

𝐸𝑆𝑆 𝑇𝑆𝑆−𝑅𝑆𝑆 𝑅𝑆𝑆 𝑅𝑆𝑆

𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = 𝑛𝜎𝑦2 = 50 ∗ 22 = 200

𝑃𝑟𝑜𝑓𝑖𝑡 = 𝛽1 + 𝛽2 ∗ 𝑁𝑜 𝐶𝑟𝑒𝑑𝑖𝑡 𝐶𝑎𝑟𝑑𝑠 + 𝜀

a) Estimate the parameters of the model and interpret the results.

Y (dependent variable) = Profit; X (explanatory variable) = No of credit cards.

∑ 𝑥𝑖 𝑦𝑖 = 4665; ∑ 𝑦𝑖2 = 78255; ∑ 𝑦𝑖 = 1078.5 ; 𝜎𝑥 = 0.44; 𝑥̅ = 4.3; 𝑛 = 15

b) Calculate and interpret the coefficient of determination.

c) Test the validity of the model for a 0.05 level of significance.

 State the hypotheses

 Determine the critical value of the statistic

a) 𝑎 = 𝑦̅ − 3.86 ∗ 𝑥̅ = 205.5 − 3.86 ∗ 16.4 = 142.2

2 1 (𝑥𝑝 − 𝑥̅ )2 1 (17 − 16.4)2

References: Lectures 6 and 7

For part B please find below two solved problems.

10 78 42 1.3186 −0.07321 −0.15417 2195

a) Calculate the average of the dependent variable.

b) The regression model is : 𝑦 = 𝛽1 + 𝛽2 ∗ 𝑋2 + 𝛽3 ∗ 𝑋3 + 𝜀

We estimate the parameters using the following formula:

1.3186 −0.07321 −0.15417 2195 218.12 ̂1

Matrix 𝑋 𝑇 𝑋 and (𝑋 𝑇 𝑋)−1 are symmetrical (!)

c) An estimator of the variance – covariance matrix of the parameters is:

𝑇𝑆𝑆 = ∑(𝑦𝑖 − 𝑦̅)2 = 𝑛𝜎2𝑦 = 10 ∗ 1067.3 = 10673

𝐸𝑆𝑆 = 𝑇𝑆𝑆 − 𝑅𝑆𝑆 = 10673 − 403.7 = 10269.3

The coefficient of determination will be:

The adjusted coefficient of determination is calculated as:

The confidence interval for the dependent variable is: 𝑦

𝛥 = 𝑡𝛼;(𝑛−3) ∗ 𝜎̂𝜀 ∗ √1 + 𝑥𝑝 (𝑋 𝑇 𝑋)−1 𝑥𝑝𝑇

1.3186 −0.07321 −0.15417 1

𝛥 = 2.365 ∗ √57.67 ∗ √1 + 0.1043 = 18.87

And the interval will be:

226 − 18.87 ≤ 𝑦𝑝 ≤ 226 + 18.87 ⇔ 207.13 ≤ 𝑦𝑝 ≤ 244.87

The following regression model was estimated on a sample of 40 observations:

𝑦𝑖 = 3.7 + 2.45 ∗ 𝑋2𝑖 + 1.3 ∗ 𝑋3𝑖 − 0.59 ∗ 𝑋4𝑖 + 𝜀̂𝑖

a) Test the validity of the model.

a) n = 40; k = number of parameters in the regression model = 4.

𝐻𝑜 : 𝛽2 = 𝛽3 = 𝛽4 = 0 (the regression model is not valid)