Inference in Simple Regression
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1 Sectn 3 Inference n Smple Regressn Havng derved the prbablty dstrbutn f the OLS ceffcents under assumptns SR SR5, we are nw n a pstn t make nferental statements abut the ppulatn parameters: hypthess tests and cnfdence ntervals. (Cnfdence) Interval estmatrs What a cnfdence nterval means: The cnfdence lmts are randm varables, the parameter s nt. Under the assumptns we have made abut the mdel, 95% f the tme ur (randm) cnfdence nterval wll nclude the actual parameter value. Cnfdence nterval s a par f randm varables l and u such that Pr.95 r anther specfed cnfdence level. l Under ur assumptns, b ~, u Ths s true always f SR6 (nrmalty) s satsfed It s true asympttcally f SR6 s nt vald but the actual dstrbutn f e has fnte furth mments If we knw then we can cnvert b t a standard nrmal varable by subtractng ts epected value and dvdng by ts standard devatn: Z b / ~, Frm prpertes f standard nrmal, we knw that Z Wth a lttle algebra: b Pr / Pr Pr.96 / b.96 /.95 Pr b.96 / b.96 /.95. Ths s the 95% nterval estmate (usually called a cnfdence nterval) fr. ~ 3 ~
2 We can t use the frmula abve unless we knw, whch we nrmally dn t. If we replace by s, then b fllws a t dstrbutn wth degrees f freedm rather than the nrmal dstrbutn. b b t ~ t se.. b s / If t c s the 5% tw-taled crtcal value fr ths t dstrbutn, then Pr b t se.. b b t se.. b.95 c c Eplan hw t fnd the crtcal value, bth theretcally and n the tables. Stata (and sme ther packages) prnts ut these cnfdence lmts based n assumptns SR SR5. Hypthess tests abut sngle ceffcents The mst cmmn test n ecnmetrcs s the t-test f the hypthess that a sngle ceffcent equals zer. Ths test s prnted ut fr each regressn ceffcent n Stata and ther statstcal packages. Dependng n the assumptns f the mdel (and whether they are vald), the tstatstc may r may nt fllw Student s t dstrbutn. bk c General frm fr calculatng a t-statstc s t, where c s the hypthetcal value s.e.bk (usually zer) that we are testng aganst and s.e. s the standard errr f the ceffcent estmatr b k. Ths test statstc s useful because we knw ts dstrbutn under the null hypthess that k = c. Thus we can determne hw lkely r unlkely t s that we wuld bserve the current sample f the null hypthess s true. Ths allws us t cntrl the Type I errr at sgnfcance level. Usng the t-statstc t test H : k = c aganst the tw-sded alternatve H : k c te that hypthess t be tested s always epressed n terms f the actual ceffcent, nt the estmated ne. Use the frmula abve t calculate the t statstc. (Stata wll prnt ut b and ts standard errr, and als the t value crrespndng t c =.) If the abslute value f the calculated t value s greater than the crtcal value, then reject the null. D eample ncludng lkng up crtcal value. ~ 3 ~
3 Alternatvely, we can cmpute the prbablty (p) value asscated wth the test: the prbablty that an utcme at least ths ncnsstent wth the null hypthess wuld ccur f the null s ndeed true. act p Pr H b c b c act b c b c PrH, where the act refers t the actual se.. b se.. b act Pr t t. H bserved/calculated value If we knw the dstrbutn f the t statstc, then we can calculate the last prbablty frm tables. Under assumptns SR SR5, the t statstc wll be asympttcally nrmal. Wth SR6 t s t wth degrees f freedm n small samples. Stata calculates the p value asscated wth the null hypthess = usng the t dstrbutn Shw dagram crrespndng t HGL s Fgure 3. n page 3: Fr gven t, shw hw t calculate p value. On same dagram shw crtcal values fr test at gven level f sgnfcance, and hw t decde the result f the test te.96 as tw-taled 5% crtcal value fr nrmal dstrbutn. Then shw the symmetry: the p value s the smallest sgnfcance level at whch the null hypthess can be rejected. One-taled test such as H : = c, H : < c. (Or H : c) Same basc prcedure, but n ths case we cncentrate the entre rejectn regn n ne tal f the dstrbutn. We reject the null f and nly f Pr[t < t act ] < crtcal value (gnrng rght tal f dstrbutn) and fal t reject fr any pstve t value n matter hw large. Other drectn f H s > c: Fal t reject null fr any negatve value f t and reject when Pr[t < t act ] > crtcal value. Present sme eamples f regressns and practce wth tests f = and = ther values. Gd (multple regressn) eample wth lts f dfferent sgnfcance levels: reg gpnts rdr satv satm takng f freshman Can d just takng t get almst sgnfcant eample fr smple regressn Testng lnear cmbnatns f parameters What f we want an nterval estmatr r hypthess test fr the value f y when =? ~ 33 ~
4 Ths wuld be an estmatr fr +. The natural estmatr s b + b What s the dstrbutn f b + b? b + b s a lnear functn f b and b, s t s nrmal (r t) f they are s t s unbased (under assumptns) Eb b Eb Eb var b b var b, var b cv b, b We can apprmate these varances and cvarance by ther sample estmatrs, and use the result t calculate a t statstc. Can als d hypthess test f such lnear cmbnatns f ceffcents. Predctn n the smple regressn mdel One f the mst cmmn tasks fr whch we use ecnmetrcs s cndtnal predctn r frecastng. We want t answer the questn What wuld y be f were sme value? Ths s eactly the same prblem we dscussed abve n estmatng the dstrbutn f b + b, whch s the OLS predctn f y fr =. OLS predctn: ŷ b b Because E e =, we predct t t be zer. Mght nt d that f we had nfrmatn abut the errr term crrespndng t ur predctn. te that we are assumng t be gven. Secndary predctn prblem ccurs f we must als predct. Frecast errr (predctn errr) s f y ˆ y. f e bb b b e E f because b s unbased, s OLS predctr s unbased OLS predctr s BLUP based n BLUE OLS estmatr What s the varance f ŷ r, equvalently, the varance f f? f b b e var f var yˆ E y yˆ b b b b e var var cv, var. ~ 34 ~
5 ~ 35 ~ Fr smple regressn under hmskedastcty, cv. b XX S ˆ var. y Predctn errr s smaller fr: Smaller errr varance Larger sample sze (thrugh bth secnd and thrd terms) Greater sample varatn n Observatns clser (X) t the mean Wth SR6 (nrmalty) r asympttcally under mre general assumptns, ~, var f f, because f s a lnear functn f nrmal varables wth mean.
6 We usually dn t knw, s we must replace t wth s. Ths makes the dstrbutn t rather than nrmal. Interval estmate fr ŷ s Pr y ˆ t.. ˆ ˆ.. ˆ c se y y y tc se y, where t c s the / crtcal value f the t dstrbutn. Measurng gdness f ft It s always f nterest t measure hw well ur regressn lne fts the data. There are several that are cmmnly reprted. Sum f Squares due t Errrs = SSE = e y y SST = Sum f Squares Ttal = y y. SSR = Sum f Squares due t Regressn = yˆ y ˆ ˆ, wth yˆ y b b. Warnng abut ntatn: sme bks use SSR fr sum f squared resduals and SSE t mean sum f squares eplaned. Fundamental regressn dentty: SST = SSR + SSE. Wrks due t the enfrced ndependence f ŷ and ê. See Append 4B. Standard errr f the estmate (regressn): Ths s ur estmate f the standard devatn f the errr term. n eˆ eˆ SSE SEE s s eˆ. Standard errr f regressn s ften (as n Stata) called rt mean squared errr r RMSE. Ceffcent f determnatn: R The R ceffcent measures the fractn f the varance n the dependent varable that s eplaned by the cvaratn wth the regressr. It has a range f (, ), wth R = meanng n relatnshp and R = meanng a perfect lnear ft. SSR SSE se ˆ R. SST SST s y R s apprmately the square f the sample crrelatn ceffcent between y and ŷ. Specfcatn ssues Scalng Des t matter hw we scale the and y varables? ~ 36 ~
7 If we add r subtract a cnstant frm etherr r y, all that s affected s the ntercept term b. Snce we are nt usually very nterested n the value f the ntercept, ths s usually meanngless. If we multply by a cnstant, the slpe estmate b wll be dvded by the same cnstant, as wll ts standard errr, leavng the t statstc unchanged. The estmated nterceptt s unchanged, as are thee resduals, SEE, and R. If we multply y by a cnstant, the slpe and ntercept estmates wll bth be multpled by the same cnstant, as wll ther standard errrs (leavng the t statstcs unchanged) and the SEE. ne f these transfrmatns has any effect n R. nlnear mdels We can easly replace ether r y wth pwers r lgs f the rgnal varables wthut cmplcatng the estmatn. What changes s the shape f the relatnshp between the levels f and y and the nterpretatn f the ceffcents. HGL Fg 4.5 n p. 4 and Table 4. n p. 43 ~ 37 ~
8 Lg-based mdels Many ecnmetrc mdels are specfed n lg term. Mst ecnmc varables are nn-negatve, s we dn t need t wrry abut negatve values. (Thugh many can be zer.) d ln d / = the percentage change nn, s the nterpretatn f ceffcents and effects s useful and easy. The g-lg mdel s a cnstant-elastcty specfcatn wth the ceffcent beng read drectly as an elastcty. Shape f lg functns s ften reasnable: ~ 38 ~
9 Shes away frm aes Mntnc wth dmnshng returns Lg f regressr nly ( lnear-lg mdel) y ln. e Change f % n changes ln by abut. and thus leads t abut a. unt abslute change n y. If ncreases by z%, ths means t s + z/ tmes as large, whch means that ts lg s ln + ln( + z/). If z s small (say, less that %) then the apprmatn s reasnable clse. Hwever, yu may want t d eact calculatns fr frmal wrk. y Partal effect n levels s, whch s mntncally ncreasng r decreasng (dependng n sgn f ) but slpe ges t zer as gets large. Lg f dependent varable nly ( lg-lnear mdel) ln y e e te that y e, s ths s clearly a dfferent errr term than when y s nt n lg terms. Change f z unts n changes ln y by z unts, s t changes y by abut z percent. The same apprmatn ssues apples here. The ncrease f unts n ln y means that y ncreases by a factr f e z, whch s apprmately + z fr small values f z. Fr larger values f z and fr mre frmal wrk, t s best t calculate the epnental drectly. y ln y y ln y Partal effect n levels s / y. ln y y y Alternatvely, e e y. Partal effect s ncreasng n abslute value as y ncreases. (te that y must always be pstve n ths mdel.) Lg f bth regressr and dependent varable ( lg-lg mdel ) ln y ln e. ln Als mples that y e e e e e v where e e, v e., The Cbb-Duglas functn takes ths frm (wth a multplcatve errr v, usually assumed t be lg-nrmally dstrbuted). Change f % n changes ln by abut., whch changes ln y by abut., whch changes y by abut %. (Bth f the apprmatn caveats abve apply here.) ~ 39 ~
10 Thus, s the pnt elastcty f y wth respect t. Ths makes lg-lg a ppular functn frm. y y ln y ln y Partal effect n levels s. y ln y ln y ln Alternatvely, ln e y e. Partal effect s cnstant n elastcty terms, but vares wth y and n level terms. Whch lg mdel t chse? Thery vs. let data decde? Thery may suggest that percentage changes are mre mprtant than abslute changes fr ne r bth varables. Incme s ften lgged f we thnk that a dublng f ncme frm $5, t $, wuld be asscated wth the same change n ther varables as a dublng frm $, t $, (rather than half as much). As suggested by the prevus eample, lggng a varable scales dwn etreme values. If mst f the sample varatn s between $, and $, (wth mean $5, and standard devatn $3,), but yu have a few values f $5, fr ncme, these are gng t be 5 standard devatns abve the mean n level terms but much less n lg terms. The lg f 5, s nly ln()=.3 unts larger than the lg f 5,. The standard devatn f the lg wuld prbably be n the range f.6 r s, s the hghly devant bservatns wuld be less than 4 standard devatns abve the mean nstead f 5. Snce we ften want ur varables t be nrmally dstrbuted, we mght try t decde whether the varable s mre lkely t be nrmally r lgnrmally dstrbuted. ~ 4 ~
11 Lg-nrmal dstrbutn te that the varus lg mdels are nt nested wth ne anther r wth We can use R t cmpare mdels f nly f the dependent varable s the same: Lnear mdel wth lnear-lg mdel B-C mdel nests lg and lnear terms fr bth dependent and ndependent varables n a nnlnear mdel. Can estmate B-C mdel and test hypthess that the relatnshp s lnear r lg.,f, B-C transfrmatn s B, ln, f =. We can d a nnlnear regressn f B(y, y ) n B(, ) and test the tw Predctn n lg and ther y-transfrmed mdelss the lnear r plynmal mdels, s t tests cannt dscrmnate between them. Lg-lnear mdel wth lg-lg mdel Ths s a cntnuus functn that equals f = and ln f =. values t see whether they are zer r ne t determne whether a lnear r lg specfcatn s preferred fr bth varables. If we run the regressn g y z e Ths prblem usually arses wh hen g y ln n y., hw wuld we predct y? ~ 4 ~
12 ln yb b E e b b. But We can predct lny by ln y E ln y ln y. E y E e e e The prblem s that even f E(e ) =, E(e e ). If e s nrmally dstrbuted wth varance e, then E e e. ln y In that case, we can predct y by yˆ c e e. Ths s a cnsstent predctn f the errr term s nrmal. In the nn-nrmal case, we can use a smple regressn t calculate the apprprate adjustment factr: ln y Run a regressn f y e, whch s a bvarate regressn wthut a cnstant term. Then adjust the predctns t get yˆ c ln y ˆe, whch, fr the sample bservatns, are just the predcted values frm the aulary regressn. Can t d a cnvenent nterval predctr because y ˆc s nt nrmal r t dstrbuted. s e ˆ Usng resduals All regressn sftware wll have a way t scatter-plt the actual and ftted values r the resduals aganst anther varable ( s ften mst useful). Dn t put resdual plt and actual/ftted plt n same dagram because f scalng. Resduals tell yu what yu are mssng n yur regressn: Functnal frm: f there s bvus curvature n the actual vs. ftted values, yu may need a nnlnear frm Heterskedastcty: f the varance f the resduals seems t be related t r anther varable, then yu may need t crrect fr t. Hw wuld yu tell ths frm resdual plt? Outlers: Are there specfc bservatns that are far frm the nrmal pattern? If s, they may ndcate that ne r mre bservatns d nt fllw the same mdel (Assumptn ). Or they may suggest an addtnal eplanatry varable that affected y n thse bservatns. Are resduals nrmally dstrbuted? If errr term s nrmal, then resduals shuld be. Jarque-Bera test ~ 4 ~
13 K JB S Tests whether skewness and kurtss f varable match the zer, three epected n nrmal dstrbutn. There are ther tests as well. ~ 43 ~
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