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Chap 3 Two Variable Regression Model The Problem of Estimation

This document summarizes key aspects of the ordinary least squares (OLS) method for estimating parameters in a linear regression model. It discusses how OLS estimates are calculated by minimizing the sum of squared residuals and describes the assumptions required for OLS to produce best linear unbiased estimates. It also defines important metrics for assessing linear regression results, such as the coefficient of determination (R2) and standard errors.

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Samina Ahmeddin
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657 views35 pages

Chap 3 Two Variable Regression Model The Problem of Estimation

This document summarizes key aspects of the ordinary least squares (OLS) method for estimating parameters in a linear regression model. It discusses how OLS estimates are calculated by minimizing the sum of squared residuals and describes the assumptions required for OLS to produce best linear unbiased estimates. It also defines important metrics for assessing linear regression results, such as the coefficient of determination (R2) and standard errors.

Uploaded by

Samina Ahmeddin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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CHAPTER 3: TWO VARIABLE REGRESSION MODEL:

THE PROBLEM OF ESTIMATION

Textbook: Damodar N. Gujarati and Dawn C Porter (2008) Basic


Econometrics, 5th edition, The McGraw-Hill Companies

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3.1 THE METHOD OF ORDINARY LEAST SQUARES
• Developed by German mathematician Carl Friedrich Gauss
• Two variables PRF:
• Corresponding SRF:

• How is SRF determined?

• We do not minimize the sum of the residuals!

• Why not?

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Figure 3.1 Least squares criterion

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3.1 THE METHOD OF ORDINARY LEAST SQUARES…cont

• We adopt the least-squares criterion


• We want to minimize the sum of the squared residuals.
• This sum is a function of estimated parameters:
• Normal equations:

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3.1 THE METHOD OF ORDINARY LEAST SQUARES…cont

• Solving the normal equations simultaneously, we obtain the


following:

• Beta2-hat can be alternatively


expressed as the following:

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Three Statistical Properties of OLS Estimators

I. The OLS estimators are expressed solely in terms of the


observable quantities (i.e. X and Y). Therefore they can
easily be computed.
II. They are point estimators (not interval estimators). Given
the sample, each estimator provide only a single (point)
value of the relevant population parameter.
III. Once the OLS estimates are obtained from the sample
data, the sample regression line can be easily obtained.

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The properties of the regression line

1. It passes through the sample means of Y and X.

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The properties of the regression line
•

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The properties of the regression line

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The properties of the regression line

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

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3.2 The Classical Linear Regression Model:
The Assumptions Underlying the Method of Least Squares

• Example of perfect multicollinearity: X1 = 2X2+X3


Y X1 X2 X3
6 5 2 1
11 10 4 2
17 11 5 1
22 16 6 4
25 19 8 3
33 22 10 2
15 11 3 5
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PRECISION OR STANDARD ERRORS OF
LEAST SQUARES ESTIMATES
• var: variance
• se: standard error
• : the constant homoscedastic
variance of ui
• : the standard error of the
estimate

• : OLS estimator of

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Gauss – Markov Theorem

• An estimator, say the OLS estimator , is said to be a best


linear unbiased estimator (BLUE) of β2 if the following hold:

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The co-efficient of determination r2

• TSS: total sum of squares


• ESS: explained sum of squares
• RSS: residual sum of squares

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The co-efficient of determination r2

The quantity r2 thus defined is known as the (sample) coefficient of determination and is the most
commonly used measure of the goodness of fit of a regression line. Verbally, r2 measures the
proportion or percentage of the total variation in Y explained by the regression model.

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The co-efficient of determination r2

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The co-efficient of determination r2

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The coefficient of correlation r

r is the sample correlation coeffcient

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Some of the properties of r

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Homework

• Study the numerical example on Page 78-79.


• Study the numerical example below. There will be questions
on the midterm exam similar to the ones in this example.

• Data is:

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Homework

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Homework

35

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