BLUE NILE COLLEGE

Department of Accounting and Finance

Econometrics for finance

BY: Yasabneh. M

1 By: Yasabneh. M 04/03/25

 Chapter One: Introduction
What is Econometrics?
Econometrics is a discipline that bridges economics,
mathematics, and statistics.
It applies mathematical and statistical methods to economic
data in order to;
 Test hypotheses
 Estimate parameters and
 Make predictions about economic behavior.
The ultimate goal of econometrics is to provide empirical
evidence for economic theories and to help policy-makers
make informed decisions.

2 By: Yasabneh. M 04/03/25

 Economic Mathematical
Theory Economics

Econometrics

Economic Mathematic
Statistics Statistics

3 By: Yasabneh. M 04/03/25

 Economic theory
.
makes statements that are
mostly qualitative in nature, while econometrics gives
empirical content to most economic theory
 Mathematical economics is to express economic theory in
mathematical form without empirical verification of the
theory, while econometrics is mainly interested in the later
Economic Statistics is mainly concerned with collecting,
processing and presenting economic data. It does not being
concerned with using the collected data to test economic
theories
 Mathematical statistics provides many of tools for
economic studies, but econometrics supplies the later with
many special methods of quantitative analysis based on
economic data

4 By: Yasabneh. M 04/03/25

 Economic Model Vs Econometric
Model
Economic models: It is an organized set of
relationships that describes the functioning
of an economic entity under a set of
simplifying assumptions. All economic
reasoning is ultimately based on models.
Economic models consist of the following
three basic structural elements.
 A set of variables
 A list of fundamental relationships and
 A number of strategic coefficients

5 By: Yasabneh. M 04/03/25

Econometric models: . The most important
characteristic of econometric relationships is that they
contain a random element which is ignored by
economic models which postulate exact relationships
between economic variables.
In econometrics the influence of these ‘other’
factors is taken into account by the
introduction into the economic relationships of
random variable
Methodology of Econometrics
Econometric methodology has the following
fundamental stages;
1. Economic Theory
oThe first step in econometrics is to develop
economic theories that describe how different
economic variables are related to each other.
6 By: Yasabneh.
oThese
M 04/03/25
theories are based on assumptions about
2. Mathematical Model
o After developing economic theories, economists use
mathematical models to formalize these theories.
o Mathematical models describe economic relationships
in terms of equations and formulas that can be used to
make predictions and test hypotheses.
 A) Selecting variables
 The process of selecting variables involves careful
consideration of the economic theory under
investigation and the variables that are expected to
have a meaningful impact on the dependent variable.
 The selection of variables is driven by both theoretical
and empirical insights.
 The first step in constructing a mathematical model is
to determine the dependent (endogenous or explained)
variable and the independent (exogenous or
7 By: Yasabneh. M
explanatory) variables.
04/03/25
 B) Specification of the model
 Once the variables are selected, the next step is to
specify the functional form of the mathematical
relationship between the dependent and
independent variables.
 This specification is guided by economic theories
and empirical evidence.
 For example, let’s consider the theory of demand,
where the quantity demanded is the dependent
variable and the price is the independent variable.
 The relationship between quantity demanded (Qd)
and price (P) can be expressed through a linear
equation: Qd = β0 + β1P where β1 < 0

8 By: Yasabneh. M 04/03/25

 3. Econometric Model
 The next step is to develop econometric models that
can be estimated using data.
 Econometric models are based on economic theories
and mathematical models and include a set of
equations that describe how different economic
variables are related to each other.
 While mathematical models are deterministic
econometric models are stochastic.
 In the theory of demand quantity demand is the
dependent variable while price is the independent
variable.
 But, there are other factors that should be incorporated
such as price of related goods, measurement error and
randomness of human behavior which can be
introduced through a stochastic disturbance term know
9 Ui,
as
By: Yasabneh. M
Qi = β0 + β1Pi + Ui where β1 < 0 04/03/25
4. Data Collection
 Once the econometric model has been developed,
the next step is to collect data on the variables
included in the model.
 This data can come from a variety of sources, such as
surveys, government statistics, or financial reports.
5. Estimation
 After collecting data, researchers use statistical
techniques to estimate the parameters of the
econometric model.
 The goal of estimation is to find the values of the
model parameters that best fit the observed data.
 By estimating the parameters, economists can
quantify the relationships between the variables and
obtain numerical values that represent the strength
10 By: Yasabneh. M
and direction of those relationships.
04/03/25
6. Hypothesis Testing
 Once the parameters are estimated, researchers can
assess their statistical significance and interpret their
economic implications.
 Hypothesis testing is often conducted to evaluate the
significance of the estimated parameters, determining
whether the relationships between variables are
statistically different from zero.
 The t-statistic and p-value are commonly used
statistical measures to assess the significance of
parameter estimates.
 Additionally, economists examine the goodness of fit
of the estimated model by assessing measures such
as the R-squared (coefficient of determination) and the
adjusted R-squared, which indicate the proportion of
the total variation in the dependent variable that can
11 By: Yasabneh. M
be explained by the independent variables.
04/03/25
7. Forecasting or Prediction
 Finally, once the model has been estimated and
tested, it can be used to make predictions about
future outcomes.
 Researchers can use the model to forecast the
behavior of economic variables in the future based
on different scenarios, such as changes in
government policy or shifts in market conditions.

12 By: Yasabneh. M 04/03/25

Basic definitions: sample, population,
random variable
 In statistical analysis, understanding the concepts
of sample, population, and random variable is
crucial for making meaningful inferences and
drawing reliable conclusions.
Population
 A population is a group of individuals, objects, or
events that share a common characteristic. It is the
entire group of interest that the researcher wishes
to study, and it often represents a large, diverse,
and complex set of data.
 Example: The population of all households in a city
is the entire group of interest for a researcher who
wishes to study household income. This population
can be
13 By: large
Yasabneh. M and diverse, and it may be impractical
04/03/25
 Sample
 It is often impractical or impossible to collect data
from the entire population due to time, cost, or
logistical constraints.
In such cases, researchers work with a subset of the
population known as a sample.
A sample is a smaller, representative subset of the
population that is carefully selected to provide
insights into the characteristics and behaviors of the
population as a whole.
 By studying the sample, researchers aim to make
inferences and draw conclusions about the larger
population from which it is drawn.
Sampling is the process of selecting a sample
involves choosing a representative group of
individuals or items from the population of interest.
The goal is to select a sample that is similar in
composition
14 By: Yasabneh. M to the population, so that inferences
04/03/25
drawn from the data are applicable to the population.
Sampling can be performed using two main
approaches: probability sampling and non-
probability sampling.
 Probability sampling
 Probability sampling is a method of selecting a
sample from a population where each element in
the population has an equal chance of being
included.
This method allows for a representative sample to
be selected, meaning that the sample is likely to
have the same characteristics as the population
from which it was drawn.
Examples of probability sampling techniques
include simple random sampling, systematic
sampling, and stratified sampling.
o 1. Simple Random Sampling:
 Simple random sampling is a widely used
probability sampling technique in which individuals
from a population
15 By: Yasabneh. M are selected in a completely
04/03/25
random manner.
o 2. Systematic Sampling:
 Systematic sampling is a probability sampling
technique that involves selecting individuals from a
population based on a predetermined pattern or
sequence.
This method is relatively simple to implement and
provides a more efficient alternative to simple
random sampling when the population is large or
when there is no readily available sampling frame.
o 3. Stratified Sampling:
Stratified sampling is a probability sampling
technique that involves dividing the population into
distinct subgroups, called strata, based on a
specific characteristic or attribute.
 The individuals within each stratum share similar
characteristics, and the goal of stratified sampling
is to ensure that the sample accurately represents
the population
16 By: Yasabneh. M in terms of the characteristic04/03/25
used
for stratification.
o 4. Cluster Sampling:
Cluster sampling is a probability sampling technique
that involves dividing the population into clusters or
groups and randomly selecting entire clusters to
form the sample.
Non-probability sampling
 Non-probability sampling, on the other hand, is a
method of selecting a sample where not all
elements in the population have an equal chance of
being included.
 This method may be used if it is difficult or
impossible to identify every element in the
population.
 Examples of non-probability sampling techniques
include convenience sampling, quota sampling, and
17 By: Yasabneh. M 04/03/25
purposive sampling.
1. Convenience Sampling:
 Convenience sampling is a non-probability sampling
technique that involves selecting individuals based
on their easy accessibility or availability.
 In convenience sampling, researchers choose
individuals who are conveniently located or readily
accessible without following a specific randomization
procedure.
 While convenience sampling may be convenient, it is
important to note that the resulting sample may not
be representative of the entire population, and the
findings may not be generalizable beyond the
selected individuals.
2. Quota Sampling:
 Quota sampling is a non-probability sampling
technique that involves selecting a sample based on
predetermined quotas for certain characteristics,
18 By: Yasabneh.
such as age, M
gender, ethnicity, or other relevant
04/03/25
Unlike probability sampling methods that use random
selection, quota sampling involves the researcher
deliberately choosing individuals to fulfill the
predetermined quotas, rather than relying on
randomization.
3. Purposive Sampling:
 In this technique, a specific group of individuals is
selected because they are believed to be most relevant
to the research question.
 This type of sampling is often used in qualitative
research.
 Purposive sampling, also known as judgmental or
selective sampling, is a non-probability sampling
technique that involves selecting a specific group of
individuals who are believed to be the most relevant
and informative for addressing the research question at
19
hand.
By: Yasabneh. M 04/03/25
Data: Cross-section, Time series,
Panel data
Data is the foundation of econometric analysis.
In econometrics, data can be classified into three
main types: cross-sectional, time-series, and panel
data.
Each type of data has its own unique characteristics
and analytical methods.
 Cross-sectional data:
Cross-sectional data is data that is collected at a
single point in time from multiple individuals,
households, firms, or other units.
This type of data is often used to compare
characteristics across different groups or units, or to
estimate relationships between variables within a
20 By: Yasabneh. M 04/03/25
particular point in time.
21 By: Yasabneh. M 04/03/25
Time-series data
 Time-series data is data that is collected over a
period of time from a single individual, household,
firm, or other unit.
 This type of data is often used to analyze changes
in variables over time, such as economic growth or
unemployment rates.
 Time-series data can be analyzed using methods
such as trend analysis, regression analysis, and
time-series modeling
 Time series data offers several advantages for
analysis and decision-making.
Table 2: Ethiopia Gross Domestic Product Time Series Data
 (hypothetical
Firstly, it data) allows for trend analysis, enabling the
Year 2015 2016 2017
identification
2018 2019
of long-term
2020
patterns and directional
changes inMofa USD)
variable61.56
over time.
22
GDP (in billions
By: Yasabneh. 72.37 80.80 89.13
04/03/25
 96.82 96.77
 Types of Variables
 Qualitative Variables are variables or characteristics which cannot
measured in quantitative form but can only be identified by name or
categories, for instance include gender.
 Quantitative Variables are variables or characteristics which can be
measured and expressed numerically.
 Quantitative variables are two types:
 Discrete variable are variables which can assume only certain values,
and there are usually "gaps" between the values, such as the number of
bedrooms in our house, number of VAT registered cafés’.
 Continuous variables are variables which can assume any value
within a specific range, such as income, weight.

23 By: Yasabneh. M 04/03/25

 Measures of centralization
Measures of centralization are used to determine
the typical or central value of a variable.
The most commonly used measures of
centralization are the mean, median, and mode.
Mean
It is calculated by summing up all the values in a
data set and then dividing the sum by the number
of observations in the data set.
The formula for the arithmetic mean is given by:

24 By: Yasabneh. M 04/03/25

 Measures of dispersion
In the field of data analysis, understanding the spread
or variability of a variable is essential for gaining
insights into the characteristics and behavior of the
data.
 Measures of dispersion serve as crucial tools in
assessing the extent to which data points deviate from
the central tendency and provide valuable information
about the distribution of values.
 Among the various measures of dispersion, the range,
variance, and standard deviation are widely employed
due to their effectiveness and interpretability.
Range
 In statistics, range is a measure of dispersion that
indicates the spread or variability of a data set.
It is defined as the difference between the largest and
smallest values in the data set. The range is calculated
25 subtracting
by By: Yasabneh. M
the smallest value from the 04/03/25
largest
 Variance
In statistical analysis, the variance is a fundamental
measure that quantifies the dispersion or spread of a
dataset.
 It provides valuable insights into the average squared
distance between individual observations and the mean
of the dataset.
 To calculate the variance, we follow a specific procedure.
 First, we compute the difference between each data
point and the mean.
These differences, known as deviations, are then squared
to eliminate negative values and emphasize the
magnitude of the deviations.
Next, we sum up all the squared deviations.
 Finally, we divide the sum by the total number of
observations to obtain the average squared deviation.
The variance serves as a critical tool in various fields,
including economics, finance, and social sciences.
It allows economists to assess the degree of variability
within
26 a variable,
By: Yasabneh. M providing important information04/03/25
about
the reliability and stability of data.
The formula for the population (σ 2 )and sample (S
2 )variance are given by;

To compute the variance of the scores of four

students in a quiz, we can follow these steps:
• 1. Calculate the mean of the scores:
• 2. Calculate the deviations from the mean:
• 3. Compute the square of the deviations:
• 4. Calculate the sum of the squared deviations:
• 5. Divide the sum of squared deviations by the
number of observations (

27 By: Yasabneh. M 04/03/25

28 By: Yasabneh. M 04/03/25
 Standard deviation
The standard deviation is a widely used measure of
dispersion that complements the variance by
providing a more interpretable understanding of the
spread of observations around the mean.
 It represents the square root of the variance and is
denoted by the symbol S. In our previous example,
we calculated the variance of the scores to be
41.67.
To find the standard deviation, we take the square
root of the variance. Mathematically, this can be
expressed as;
 =6.46

29 By: Yasabneh. M 04/03/25