Eco 205: Econometrics • Any questions? 1 Population Linear Regression Model Yi = b 0 + b1X i + u i population data point Y pop slope = b1 Observed Value of Y for X3 u3 u11 Y11 b0 X3 X11 X 2 Sample Regression Equation chosen in sample not chosen in sample ˆ = bˆ + bˆ X Y i 0 1 i Y Y3 estimated error for X3 (residual) uˆ 3 estimated intercept = pop slope = b1 u3 Yˆ3 bˆ 0 b0 estimated slope = bˆ1 X3 X 3 The OLS estimator solves n 2 ˆ ˆ min å[Yi - (b 0 + b1X i )] bˆ0 , bˆ1 i= 1 4 5 California Test Score/Class Size data • Interpretations 6 Predicted values & residuals: 7 OLS regression: STATA output regress testscr Regression str, robust with robust standard errors Number of obs F( 1, 418) Prob > F R-squared Root MSE = = = = = 420 19.26 0.0000 0.0512 18.581 ------------------------------------------------------------------------| Robust testscr | Coef. Std. Err. t P>|t| [95% Conf. Interval] --------+---------------------------------------------------------------str | -2.279808 .5194892 -4.39 0.000 -3.300945 -1.258671 _cons | 698.933 10.36436 67.44 0.000 678.5602 719.3057 ------------------------------------------------------------------------- 8 Measures of Fit 9 The Standard Error of the Regression (SER) 10 Root Mean Squared Error (RMSE) 11 2 R and SER Example 12 The Least Squares Assumptions 13 LSA #1: E(u|X = x) = 0 14 LSA #2: (Xi,Yi), i = 1,…,n are i.i.d. LSA #3: E(X4) < ∞ and E(Y4) < ∞ 15 OLS can be sensitive to an outlier 16 Sampling Distribution of bˆ1 17 Some Preliminary Algebra … 18 n bˆ1 - b1 = å( X i= 1 n n i - X )( ui - u ) 2 ( X X ) å i i= 1 = å( X i - X )ui i =1 n 2 ( X X ) å i i= 1 19 Now we can calculate E( bˆ1) and var( bˆ1 ) é n ù ê å ( X i - X )ui ú ú E [ bˆ1 ] = E [b1] + E ê i=n1 ê 2 ú ê å( Xi - X) ú ë i=1 û é n ù ê å ( X i - X ) E [ u i X i ]ú ú= ? E [ bˆ1 ] = b1 + E ê i=1 n ê ú 2 å( Xi - X ) ú ê ë û i= 1 20 Next calculate var( bˆ1) 21 22 The larger the variance of X, the smaller the variance of bˆ1 There are the same number of black and blue dots – using which would you get a more accurate regression line? 23 What is the sampling distribution of bˆ ? 1 24 We are now ready to turn to hypothesis tests & confidence intervals … 25