Lecture 4(多元二)概要1.pptVIP

Lecture 4 Econ 488 Ordinary Least Squares (OLS) Objective of OLS ? Minimize the sum of squared residuals: where Remember that OLS is not the only possible estimator of the βs. But OLS is the best estimator under certain assumptions… Classical Assumptions 1. Regression is linear in parameters 2. Error term has zero population mean 3. Error term is not correlated with X’s 4. No serial correlation 5. No heteroskedasticity 6. No perfect multicollinearity and we usually add: 7. Error term is normally distributed Assumption 1: Linearity The regression model: A) is linear It can be written as This doesn’t mean that the theory must be linear For example… suppose we believe that CEO salary is related to the firm’s sales and CEO’s tenure. We might believe the model is: Assumption 1: Linearity The regression model: B) is correctly specified The model must have the right variables No omitted variables The model must have the correct functional form This is all untestable ? We need to rely on economic theory. Assumption 1: Linearity The regression model: C) must have an additive error term The model must have + εi Assumption 2: E(εi)=0 Error term has a zero population mean E(εi)=0 Each observation has a random error with a mean of zero What if E(εi)≠0? This is actually fixed by adding a constant (AKA intercept) term Assumption 2: E(εi)=0 Example: Suppose instead the mean of εi was -4. Then we know E(εi+4)=0 We can add 4 to the error term and subtract 4 from the constant term: Yi =β0+ β1Xi+εi Yi =(β0-4)+ β1Xi+(εi+4) Assumption 2: E(εi)=0 Yi =β0+ β1Xi+εi Yi =(β0-4)+ β1Xi+(εi+4) We can rewrite: Yi =β0*+ β1Xi+εi* Where β0*= β0-4 and εi*=εi+4 Now E(εi*)=0, so we are OK. Assumption 3: Exogeneity Important!! All explanatory variables are uncorrelated with the error term E(εi|X1i,X2i,…, XKi,)=0 Explanatory variables are determined outside of the model (They are exogenous) Assumption 3: Exogeneity What happens if assumption 3 is violated? Suppo