F-tests continued.ppt

F-tests continued Introduction Discuss the problems associated with structural breaks in the data. Examine the Chow test for a structural break. Assess an example of the use of the Chow test and ways to solve the problem of structural breaks. Introduce the problem of multicollinearity. Structural Breaks Structural breaks can occur in time series data or cross sectional data, when there is a sudden change in the relationship being examined. Examples include sudden policy changes such as a change in government or sudden move in asset prices (1987) or serious international disaster such as a civil war We then need to decide whether 2 separate regression lines are more efficient than a single regression. Structural Break in 1997 Structural Break In this example a single regression line is not a good fit of the data due to the obvious structural break in 1997. We need to test if a structural break has occurred in 1997, usually the break is not as obvious as this. We will use the Chow test, which is a variation of the F-test for a restriction Chow Test (stages in using test) Run the regression using all the observations, before and after the structural break, collect the RSS Run 2 separate regressions, one before, RSS(1) and one after, RSS(2) the structural break. Calculate the test statistic using the following formulae: Chow Test Chow Test The final stage of the Chow Test is to compare the test statistic with the critical value from the F-Tables. The null hypothesis in this case is structural stability, if we reject the null hypothesis, it means we have a structural break in the data We then need to decide how to overcome this break. Chow Test If there is evidence of a structural break, it may mean we need to split the data into 2 samples and run separate regressions. Another method to overcome this problem is to use dummy variables (To be covered later in term), the benefit of this approach is that we do not lose any degrees of freedom through a loss of observations. C