ReviewofProbabilityandStatistics.pptVIP

Econ 30031 - Prof. Buckles Multiple Regression Analysis y = b0 + b1x1 + b2x2 + . . . bkxk + u 1. Estimation Parallels with Simple Regression b0 is still the intercept b1 to bk all called slope parameters u is still the error term (or disturbance) Still need to make a zero conditional mean assumption, so now assume that E(u|x1,x2, …,xk) = 0 Still minimizing the sum of squared residuals, so have k+1 first order conditions Interpreting Multiple Regression Simple vs Multiple Reg Estimate Goodness-of-Fit (continued) More about R-squared R2 can never decrease when another independent variable is added to a regression, and usually will increase Because R2 will usually increase with the number of independent variables, it is not a good way to compare models Too Many or Too Few Variables What happens if we include variables in our specification that don’t belong? There is no effect on our parameter estimate, and OLS remains unbiased What if we exclude a variable from our specification that does belong? OLS will usually be biased Omitted Variable Bias Omitted Variable Bias (cont) Omitted Variable Bias (cont) Omitted Variable Bias (cont) Summary of Direction of Bias Omitted Variable Bias Summary Two cases where bias is equal to zero b2 = 0, that is x2 doesn’t really belong in model x1 and x2 are uncorrelated in the sample If correlation between x2 , x1 and x2 , y is the same direction, bias will be positive If correlation between x2 , x1 and x2 , y is the opposite direction, bias will be negative The More General Case Technically, can only sign the bias for the more general case if all of the included x’s are uncorrelated Typically, then, we work through the bias assuming the x’s are uncorrelated, as a useful guide even if this assumption is not strictly true Variance of OLS (cont) Let x stand for (x1, x2,…xk) Assuming that Var(u|x) = s2 also implies that Var(y| x) = s2 The 4 assumptions for unbiasedness, plus this homoskedasticity assumption are k