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EBE Heteroscedasticity

This document discusses heteroscedasticity in regression analysis. Heteroscedasticity occurs when the variance of the error term is not constant, violating an assumption of ordinary least squares regression. If present, it means that OLS estimates are still unbiased but less efficient and statistical tests may not be reliable. The document outlines several ways to detect heteroscedasticity, including graphs and formal tests, and recommends remedies such as weighted least squares or using robust standard errors.

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Harsha Dutta
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296 views

EBE Heteroscedasticity

This document discusses heteroscedasticity in regression analysis. Heteroscedasticity occurs when the variance of the error term is not constant, violating an assumption of ordinary least squares regression. If present, it means that OLS estimates are still unbiased but less efficient and statistical tests may not be reliable. The document outlines several ways to detect heteroscedasticity, including graphs and formal tests, and recommends remedies such as weighted least squares or using robust standard errors.

Uploaded by

Harsha Dutta
Copyright
© © All Rights Reserved
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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HETEROSCEDASTICITY

REGRESSION DIAGNOSTIC II:


HETEROSCEDASTICITY

HETEROSCEDASTICITY
One of the assumptions of the classical linear
regression (CLRM) is that the variance of ui, the
error term, is constant, or homoscedastic.
Reasons are many, including:
The presence of outliers in the data
Incorrect functional form of the regression model
Incorrect transformation of data
Mixing observations with different measures of scale
(such as mixing high-income households with lowincome households)

CONSEQUENCES
If heteroscedasticity exists, several consequences
ensue:
The OLS estimators are still unbiased and consistent, yet the
estimators are less efficient, making statistical inference less
reliable (i.e., the estimated t values may not be reliable).
Thus, estimators are not best linear unbiased estimators
(BLUE); they are simply linear unbiased estimators (LUE).
In the presence of heteroscedasticity, the BLUE estimators
are provided by the method of weighted least squares (WLS).

DETECTION OF HETEROSCEDASTICITY
Graph histogram of squared residuals
Graph squared residuals against predicted Y
Whites Test of Heteroscedasticity
Other tests such as Park,
Glejser,
Spearmans rank correlation, and
Goldfeld-Quandt tests of heteroscedasticity

REMEDIAL MEASURES
What should we do if we detect heteroscedasticity?
Use method of Weighted Least Squares (WLS)
Divide each observation by the (heteroscedastic) i and estimate the
transformed model by OLS (yet true variance is rarely known)
If the true error variance is proportional to the square of one of the
regressors, we can divide both sides of the equation by that variable
and run the transformed regression

Take natural log of dependent variable


Use Whites heteroscedasticity-consistent standard errors or
robust standard errors
Valid in large samples

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