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APPLIED ECONOMICS
SUBMITTED TO
MR, FALAK SHER
SUBMITTED BY
QAISAR SHAHZAD
ROLL NO
BECF15M033
SEMESTER
8TH
DEPARTMENT
ECONOMICS
UNIVERSITY OF SARGODHA
Multicollinearity:
When there is high correlation between independent variable or highly correlated to
each other.
R square value is high.
Prob value of t-statistics is insignificant.
Sign of co-efficient is not according to economic theory.
1) Correlation:
X2 X3 Y
X2 1 0.999 0.857
X3 0.999 1 0.857
Y 0.857 0.857 1
In the above table, we want to check the correlation between X2 & X3. The above
table shows that X2 & X3 is highly co-related to each other (i-e 0.99). The change in the
dependent variable is cause by X2 & X3 i-e 0.99. As results, there is Multicollinearity
problem in the data.
2) Regression:
We run multiple regression in E-views software.
Dependent Variable: Y
Method: Least Squares
Date: 03/16/19 Time: 15:50
Sample: 1 25
Included observations: 25
H0 = high Multicollinearity
H1 = No Multicollinearity
The output of E-views shows that the Prob value of t-Statistic is insignificant. So we accept
HO and reject H1 and there is Multicollinearity problem in the data.
3) Auxiliary Regression:
X2 = f(X3)
Dependent Variable: X2
Method: Least Squares
Date: 03/16/19 Time: 16:11
Sample: 1 25
Included observations: 25
The results of Auxiliary regression shows that R^2 value is too high, which indicate that
there is Multicollinearity problem in the data.
X3 = f (X2)
Dependent Variable: X3
Method: Least Squares
Date: 03/16/19 Time: 16:16
Sample: 1 25
Included observations: 25
The results of Auxiliary regression shows that R^2 value (i-e 0.999) is too high, which
indicate that there is Multicollinearity problem in the data.
4) Omitting Independent Variable (X3):
Y = f (X2)
Dependent Variable: Y
Method: Least Squares
Date: 03/16/19 Time: 16:21
Sample: 1 25
Included observations: 25
When we omit the X3 variable then results of regression shows that Prob value of t-Statistic is
significant and there is no Multicollinearity problem in the data, because we accept H1 and
reject Ho.
Y = f (X3)
Dependent Variable: Y
Method: Least Squares
Date: 03/16/19 Time: 16:26
Sample: 1 25
Included observations: 25