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Chapter-I

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olexsufiyan
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Chapter 1

Introduction to Econometrics

1
01/22/25
Introduction:
Econometrics

• What is Econometrics?

– Literal meaning is “measurement in economics”.

– Econometrics refers to the application of statistical methods to


economic data to lend empirical support for the models
constructed, for estimating economic relationships, for testing
economic theories, and for evaluating and implementing
government and business policy.

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Econometrics Approach

• Econometrics Approach
• The econometrics approach are used to obtain the
values of parameters which are essentially the
coefficients of the mathematical form of the economic
relationships.
• The econometric relationships depict the random
behaviour of economic relationships which are
generally not considered in economics and mathematical
formulations.

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Econometrics Model vs. Economic Model

• Econometric model is a simplified representation of


a real-world process. It should be representative in
the sense that it should contain the salient features
of the phenomena under study.
• Econometric modeling is to have a simple model to
explain a complex phenomenon.
• An economic model is a set of assumptions that
describes the behaviour of an economy, or more
generally, a phenomenon.
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Econometrics Model

• An econometric model consists of


• a set of equations describing the behaviour. These equations are derived
from the economic model and have two parts – observed variables and
disturbances.
• statement about the errors in the observed values of variables.
• a specification of the probability distribution of disturbances.

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Aim of Econometrics Model

• The three main aims econometrics are as follows:


– Formulation and specification of econometric models
– Estimation and testing of models
– Use of models

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Different Types of Data for Econometric Analysis
• There are 3 types of data which econometricians might use for analysis:
1. Time series data
2. Cross-sectional data
3. Panel data, a combination of 1. & 2.

• The data may be quantitative (e.g. exchange rates, stock prices, number of
shares outstanding), or qualitative (e.g. day of the week).

• Examples of time series data


Series Frequency
GNP or unemployment monthly, or quarterly
government budget deficit annually
money supply weekly
value of a stock market index as transactions occur

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Time Series versus Cross-sectional Data

• Examples of Problems that Could be Tackled Using a Time Series Regression


- How the value of a country’s stock index has varied with that country’s
macroeconomic fundamentals.
- How the value of a company’s stock price has varied when it announced the
value of its dividend payment.
- The effect on a country’s currency of an increase in its interest rate

• Cross-sectional data are data on one or more variables collected at a single


point in time, e.g.
- A poll of usage of internet stock broking services
- Cross-section of stock returns on the New York Stock Exchange
- A sample of bond credit ratings for UK banks

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Cross-sectional and Panel Data

• Examples of Problems that Could be Tackled Using a Cross-Sectional Regression


- The relationship between company size and the return to investing in its shares
- The relationship between a country’s GDP level and the probability that the
government will default on its sovereign debt.

• Panel Data has the dimensions of both time series and cross-sections, e.g. the
daily prices of a number of blue chip stocks over two years.

• Notation:
– Time series data: each observation by the letter t and the total number of observations by T
– Cross-sectional data: each observation by the letter i and the total number of observations by N
– Note: In this text, T denotes total number of observations for both data. Natural ordering of data
is relevant for time-series.

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Example
Cross-Sectional
ObsNO Year Unemp GNP
1 1950 15.4 878.4
2 1951 16 925
3 1952 14.8 1015.9
….

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Panel data Example
A two-year panel data set on crime and related statistics for

150 cities in the United States .


ObsNo City Year Murders Population Unem Police

1 1 1986 5 350000 8.7 440

2 1 1990 8 359000 7.2 471

3 2 1986 2 64000 5.4 75

4 2 1990 1 6500 5.5 75

297 149 1986 10 260000 9.6 296

298 149 1990 6 245000 9.8 334

299 150 1986 25 543000 4.3 520

300 150 1990 32 546000 5.2 596

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Continuous and Discrete Data

• Continuous data can take on any value and are not confined to take specific
numbers.

• Their values are limited only by precision.


– For example, the rental yield on a property could be 6.2%, 6.24%, or 6.238%.

• On the other hand, discrete data can only take on certain values, which are usually
integers
– For instance, the number of shares traded during a day.

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Cardinal, Ordinal and Nominal Numbers

• Another way in which we could classify numbers is according to whether they are
cardinal, ordinal, or nominal.

• Cardinal numbers are those where the actual numerical values that a particular
variable takes have meaning, and where there is an equal distance between the
numerical values.
– Examples of cardinal numbers would be the price of a share or of a building.

• Ordinal numbers can only be interpreted as providing a position or an ordering.


– Thus, for cardinal numbers, 12 implies a measure that is `twice as good' as 6. On the
other hand, for an ordinal scale, 12 may be viewed as `better' than 6, but could not be
considered twice as good. Examples of ordinal numbers would be the position of a
runner in a race.

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Cardinal, Ordinal and Nominal Numbers (Cont’d)

• Nominal numbers occur where there is no natural ordering of the values at all.
– Such data often arise when numerical values are arbitrarily assigned, such as telephone
numbers or when codings are assigned to qualitative data (e.g. when describing the
exchange that a US stock is traded on i.e. 1 represents NYSE, 2 represents NASDAQ
etc.)

• Cardinal, ordinal and nominal variables may require different modelling


approaches or at least different treatments.

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4.Dummy variable data

• When the variables are qualitative in nature, then the data is recorded in the form
of the indicator function.
• The values of the variables do not reflect the magnitude of the data. They reflect
only the presence/absence of a characteristic.
• For example, variables like religion, sex, taste, etc. are qualitative variables. The variable `sex’ takes
two values – male or female, the variable `taste’ takes values-like or dislike etc. Such values are
denoted by the dummy variable. For example, these values can be represented as ‘1’ represents male
and ‘0’ represents female. Similarly, ‘1’ represents the liking of taste, and ‘0’ represents the disliking
of taste.

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End of the chapter
Thank You!

01/22/25

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