Lecture 14Heteroskedasticityand Serial Correlation.ppt

Lecture 14:Heteroskedasticityand Serial Correlation Heteroskedasticity(Chapter 10.6–10.7) Serial Correlation(Chapter 11.1–11.3) Agenda Review Feasible GLS (Chapter 10.6) White Robust Standard Errors (Chapter 10.7) Serial Correlation (Chapter 11.1) OLS and Serial Correlation (Chapter 11.2) Newey–West Estimated Standard Errors (Chapter 11.2) Testing for Serial Correlation (Chapter 11.3) Review In the last lecture, we began relaxing the Gauss–Markov assumptions, starting with the assumption of homoskedasticity. Under heteroskedasticity, OLS is still unbiased. OLS is no longer efficient. OLS e.s.e.’s are incorrect, so C.I., t-, and F- statistics are incorrect. Review (cont.) Under heteroskedasticity, For a straight line through the origin, Review (cont.) We can use squared residuals to test for heteroskedasticity. In the White test, we regress the squared residuals against all explanators, squares of explanators, and interactions of explanators. The nR2 of the auxilliary equation is distributed Chi-squared. Review (cont.) The Breusch–Pagan test is similar, but the econometrician chooses the explanators for the auxilliary equation. Review (cont.) Under heteroskedasticity, the BLUE Estimator is Generalized Least Squares. To implement GLS: Divide all variables by di Perform OLS on the transformed variables. If we have used the correct di , the transformed data are homoskedastic. Review (cont.) For example, consider the relationship We are concerned that Var(ei) may vary with income. We need to make an assumption about how Var(ei) varies with income. Review (cont.) An initial guess: di = incomei If we have modeled heteroskedasticity correctly, then the BLUE Estimator is Review (cont.) If we have the correct model of heteroskedasticity, then OLS with the transformed data should be homoskedastic. Using a White test, we reject the null hypothesis of homoskedasticity of the model with transformed data. GLS: An Example Our first guess didn’t work very well. Let’s try Th