Scribd
Upload
10 views6 pages

eco

The document discusses simple regression, focusing on the relationship between one dependent variable (y) and one independent variable (x). It highlights examples such as asset returns and stock prices, and introduces methods for estimating coefficients, including the method of moments and maximum likelihood. The Ordinary Least Squares (OLS) method is explained as a technique for minimizing the sum of squared distances from data points to the regression line.

Uploaded by

Thy Phạm
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
10 views6 pages

eco

The document discusses simple regression, focusing on the relationship between one dependent variable (y) and one independent variable (x). It highlights examples such as asset returns and stock prices, and introduces methods for estimating coefficients, including the method of moments and maximum likelihood. The Ordinary Least Squares (OLS) method is explained as a technique for minimizing the sum of squared distances from data points to the regression line.

Uploaded by

Thy Phạm
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 6

3.

3 Simple Regression
For simplicity, suppose for now that it is believed that y depends on only
one x variable. Again, this is of course a severely restricted case, but the
case of more explanatory variables will be considered in Chapter 4. Three
examples of the kind of relationship that may be of interest include

How asset returns vary with their level of market risk


Measuring the long-term relationship between stock prices and
dividends
Constructing an optimal hedge ratio
Suppose that a researcher has some idea that there should be a relationship
between two variables y and x, and that financial theory suggests that an
an increase in x will lead to an increase in y. A sensible first stage to testing
whether there is indeed an association between the variables would be to
form a scatter plot of them. Suppose that the outcome of this plot is Figure
3.1.
Two alternative estimation methods (for determining the appropriate
values of the coefficients α and β) are the method of moments and the
method of maximum likelihood. A generalized version of the method of
moments, due to Hansen (1982), is popular, but beyond the scope of this
book. The method of maximum likelihood is also widely employed, and
will be discussed in detail in Chapter 9.

Suppose now, for ease of exposition, that the sample of data contains
only five observations. The method of OLS entails taking each vertical
distance from the point to the line, squaring it and then minimizing the
total sum of the areas of squares (hence ‘least squares’), as shown in
Figure 3.3. This can be viewed as equivalent to minimizing the sum of the
areas of the squares drawn from the points to the line.

You might also like