Econometrics: Damodar Gujarati

ECONOMETRICS
Damodar Gujarati:
Basic Econometrics
Econometrics by Examples
Wooldridge:
Introductory Econometrics
Maddala:
Introduction to Econometrics
Econometrics means economic

measurement.
as the quantitative analysis of actual economic
phenomena based on the simultaneous
development of theory and observation,
related by appropriate methods of inference
as the social science in which the tools of
economic theory, mathematics, and statistical
inference are applied to the analysis of
economic phenomena.
Econometrics is concerned with the empirical
determination of economic laws
Linear Regression Model
The linear regression model

The LRM in its general form may be written as:
Yj =B1 +B2X2i +B3 X 3i + ... +BkXki +ui
The variable Y
is known as the dependent
variable. or regressand,
X variables are known as the explanatory
variables, predictors, covariates, or regressors, and
U is known as a random, or stochastic, error term.
The subscript i denotes the ith observation.
For ease of exposition. we will write Eq. (1.1) as:
Yi = BX + ui
(1.2) population or true model.
A deterministic component, BX,
A nonsystematic, or random component, ui
Eq. (1.2) states that an individual Yi value is
equal to the mean value of the population of
which he or she is a member plus or minus a
random term..
If Y represents family expenditure on food and X
represents family income. Eq. (1.2) states that
The food expenditure of an individual family is
equal to the mean food expenditure of all the
families with the same level of income, plus or
minus a random component that may vary from
individual to individual and that may depend on
several factors.
Collectively, Betas are regression coefficients
The nature of the Y variable

Y is a Random Variable, measured on four different Scales
Ratio scale
Ratio of Two variables
Distance between two variables
Ordering of variables
Interval Scale
Do not hold first property of ratio scale(Time series, 2007/2015
is meaningless)
Ordinal Scale
Do not Satisfy first two properties of Ratio Scale(Grading,
Income)
Nominal Scale: (Dummy or Categorical)

Gender , Marital status religion,
The nature of the X

variables
Regressors are Non-Random( Fixed)
Measurement scale
The nature of the Stochastic error

term ui
Catchall (lack of data, measurement errors..)
The nature of the regression

coefficients, Bs
In CLRM, Bs are fixed numbers
Bayesian statistics, treats the regression
coefficient as random
The Meaning of linear

regression
Linear: Linearity in parameters(Reg.
coefficients)
lnX , 1/X , X 2 are linear
The nature of Sources of

data
Time Series (Yt, Xt)
Autocorrelation ( u t , u t-1 are correlated)
Non-Stationary (mean and variance vary
systematically over time)
Stationary
Cross-Sectional Data (Yi, Xi)

Hetroscedasticity , Heterogeneity
Homoscedastic
The nature of Sources of

data
Panel, Longitudinal or micro-panel data
(Yit , Xit)
Types of Econometrics
Econometric theory and applied
econometrics
Econometric theory usually involves
the development of new methods
and the study of their properties.
Applied econometrics concerns the
development and application of tools
to solve relevant practical questions.
Methodology:
1.Statement of theory or hypothesis.
2. Specification of the mathematical model of
the theory
3. Specification of the statistical, or
econometric model
4. Obtaining the data
5. Estimation of the parameters of the
econometric model
6. Hypothesis testing
7. Forecasting or prediction
8. Using the model for control or policy
purposes.
Assumptions of Linear
Regression Model
1. The regression model is linear in the
parameters,
Yi = 1 + 2Xi + ui
2: The regressors are assumed to be fixed or
nonstochastic(Fixed values in repeated

samples)
3: Zero mean value of disturbance ui. Given
the value of X, the mean, or expected, value
of the random disturbance term ui is zero.
Symbolically, we have
E(ui |Xi) = 0
4.
Homoscedasticity or equal
variance of ui. Given the value
of X, the variance of ui is the
same for all observations. That is,
the conditional variances of ui are
identical. Symbolically, we have
var (ui |Xi) = 2
5. No autocorrelation between
the disturbances. Given any two
X values,
Xi and Xj (i j), the correlation
between any two ui and uj (i j) is
zero. Symbolically,
cov (ui, uj |Xi, Xj) = 0
where i and j are two different
observations
6. There are no perfect linear

relationships among the X
variables (No Multicollinearity)
X
= 2X1 + 4X
7. The number of observations n

must be greater than the
number of parameters to be
estimated. Alternatively, the
number of observations n must
be greater than the number of
explanatory variables.
No Specification Bias
8:
ui
N ( 0 , sigma-sq)
GaussMarkov Theorem
Given the assumptions of the
classical linear regression model, the
least-squares estimators, in the class
of unbiased linear estimators, have
minimum variance, that is, they are
BLUE
BLUE Estimators
On the basis of assumptions 1 to 7
Estimators are Best, Linear, Unbiased,
Efficient.
Best: Minimum variance
Linear
Unbiased: Expected value of estimator
(E(theta hat = theta) is equal to parameter
Efficient: Incorporate all data points
THE CONCEPT OF POPULATION

REGRESSION
FUNCTION (PRF)
E(Y | Xi) = f (Xi)
E(Y | Xi) = 1 + 2Xi
where 1 and 2 are unknown but fixed parameters known

as the regression coefficients; 1 and 2 are also known as
intercept and slope coefficients, Respectively
THE METHOD OF ORDINARY

LEAST SQUARES
PRF can be estimated from the SRF
by taking first derivative and put

equals zero we get normal eq. as
Solving normal eq.
THE COEFFICIENT OF DETERMINATION

r^2 MEASURE OF GOODNESS OF FIT
TSS = ESS + RSS

TSS total sum of squares
ESS Explained sum of squares
RSS Residual Sum of squares

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ECONOMETRICS

Econometrics means economic

Linear Regression Model

The linear regression model

The nature of the Y variable

Nominal Scale: (Dummy or Categorical)

The nature of the X

The nature of the Stochastic error

The nature of the regression

The Meaning of linear

The nature of Sources of

Cross-Sectional Data (Yi, Xi)

The nature of Sources of

nonstochastic(Fixed values in repeated

6. There are no perfect linear

7. The number of observations n

THE CONCEPT OF POPULATION

where 1 and 2 are unknown but fixed parameters known

THE METHOD OF ORDINARY

by taking first derivative and put

Solving normal eq.

THE COEFFICIENT OF DETERMINATION

TSS = ESS + RSS

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