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7basic Econometrics Chapter Vi

This chapter discusses extensions to the basic two-variable linear regression model, including regression through the origin, scaling and units of measurement, and different functional forms like log-linear, semi-log, and reciprocal models. It provides equations to estimate coefficients for each model and explains how to interpret the slope coefficient in terms of elasticity and growth rates. Examples are given to illustrate the concepts and a table summarizes the different functional forms.

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Afsheena Mecca
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155 views

7basic Econometrics Chapter Vi

This chapter discusses extensions to the basic two-variable linear regression model, including regression through the origin, scaling and units of measurement, and different functional forms like log-linear, semi-log, and reciprocal models. It provides equations to estimate coefficients for each model and explains how to interpret the slope coefficient in terms of elasticity and growth rates. Examples are given to illustrate the concepts and a table summarizes the different functional forms.

Uploaded by

Afsheena Mecca
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Basic Econometrics

Chapter 6
EXTENSIONS OF THE
TWO-VARIABLE LINEAR
REGRESSION MODEL

1
Prof. Himayatullah May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE
LINEAR REGRESSION MODELS

6-1. Regression through the origin


 The SRF form of regression:
 Yi = b^2X i + u^ i (6.1.5)

 Comparison two types of regressions:


* Regression through-origin model and
* Regression with intercept

2
Prof. Himayatullah May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE
LINEAR REGRESSION MODELS

6-1. Regression through the origin


Comparison two types of regressions:

b^2 = SXiYi/SX2i (6.1.6) O


b^2 = Sxiyi/Sx2i (3.1.6) I
var(b^2) = s2/ SX2i (6.1.7) O
var(b^2) = s2/ Sx2i (3.3.1) I
s^2 = S(u^i)2/(n-1) (6.1.8) O
s^2 = S(u^i)2/(n-2) (3.3.5) I

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Prof. Himayatullah May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE LINEAR
REGRESSION MODELS
6-1. Regression through the origin
 r2 for regression through-origin model
Raw r2 = (SXiYi)2 /SX2i SY2i (6.1.9)
 Note: Without very strong a priory expectation, well
advise is sticking to the conventional, intercept-
present model. If intercept equals to zero
statistically, for practical purposes we have a
regression through the origin. If in fact there is an
intercept in the model but we insist on fitting a
regression through the origin, we would be
committing a specification error
4
Prof. Himayatullah May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE
LINEAR REGRESSION MODELS

6-1. Regression through the origin


 Illustrative Examples:
1) Capital Asset Pricing Model - CAPM (page 156)
2) Market Model (page 157)
3) The Characteristic Line of Portfolio Theory
(page 159)

5
Prof. Himayatullah May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE LINEAR
REGRESSION MODELS
6-2. Scaling and units of measurement

 Let Yi = b^1 + b^2Xi + u^ i (6.2.1)


 Define Y*i=w 1 Y i and X*i=w 2 X i then:
 b*^2 = (w1/w2) b^2 (6.2.15)
 b*^1 = w1b^1 (6.2.16)
 s*^2 = w12s^2 (6.2.17)
 Var(b*^1) = w21 Var(b^1) (6.2.18)
 Var(b*^2) = (w1/w2)2 Var(b^2) (6.2.19)
 r2xy = r2x*y* (6.2.20)
6
Prof. Himayatullah May 2004
Chapter 6
EXTENSIONS OF THE TWO-VARIABLE
LINEAR REGRESSION MODELS
6-2. Scaling and units of measurement
 From one scale of measurement, one can derive the results
based on another scale of measurement. If w1= w2 the
intercept and standard error are both multiplied by w1. If
w2=1 and scale of Y changed by w1, then all coefficients and
standard errors are all multiplied by w1. If w1=1 and scale of
X changed by w2, then only slope coefficient and its standard
error are multiplied by 1/w2. Transformation from (Y,X) to
(Y*,X*) scale does not affect the properties of OLS
Estimators
 A numerical example: (pages 161, 163-165)
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Prof. Himayatullah May 2004
6-3. Functional form of regression model

 The log-linear model


 Semi-log model
 Reciprocal model

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Prof. Himayatullah May 2004
6-4. How to measure elasticity
The log-linear model
 Exponential regression model:
 Yi= b1Xi b2 e u i (6.4.1)
By taking log to the base e of both side:
 lnYi = lnb1 +b2lnXi + ui , by setting lnb1 = a =>
 lnYi = a +b2lnXi + ui (6.4.3)
(log-log, or double-log, or log-linear model)
This can be estimated by OLS by letting
 Y*i = a +b2X*i + ui , where Y*i=lnYi, X*i=lnXi ;
b2 measures the ELASTICITY of Y respect to X, that is,
percentage change in Y for a given (small) percentage
change in X.
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Prof. Himayatullah May 2004
6-4. How to measure elasticity

The log-linear model


The elasticity E of a variable Y with
respect to variable X is defined as:
E=dY/dX=(% change in Y)/(% change in X)
~ [(Y/Y) x 100] / [(X/X) x100]=
= (Y/X)x (X/Y) = slope x (X/Y)

 An illustrative example: The coffee


demand function (pages 167-168)
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Prof. Himayatullah May 2004
6-5. Semi-log model:
Log-lin and Lin-log Models

 How to measure the growth rate: The log-lin model


 Y t = Y0 (1+r) t (6.5.1)
 lnYt = lnY0 + t ln(1+r) (6.5.2)
 lnYt = b1 + b2t , called constant growth model (6.5.5)
where b1 = lnY0 ; b2 = ln(1+r)
 lnYt = b1 + b2t + ui (6.5.6)
 It is Semi-log model, or log-lin model. The slope
coefficient measures the constant proportional or
relative change in Y for a given absolute change in the
value of the regressor (t)
 b2 = (Relative change in regressand)/(Absolute change
in regressor) (6.5.7)
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Prof. Himayatullah May 2004
6-5. Semi-log model:
Log-lin and Lin-log Models
 Instantaneous Vs. compound rate of growth
 b2 is instantaneous rate of growth
 antilog(b2) – 1 is compound rate of growth
The linear trend model
 Yt = b1 + b2t + ut (6.5.9)
 If b2 > 0, there is an upward trend in Y
 If b2 < 0, there is an downward trend in Y
 Note: (i) Cannot compare the r2 values of
models (6.5.5) and (6.5.9) because the
regressands in the two models are different,
(ii) Such models may be appropriate only if a
time series is stationary.
12
Prof. Himayatullah May 2004
6-5. Semi-log model:
Log-lin and Lin-log Models
 The lin-log model:
 Yi = b1 +b2lnXi + ui (6.5.11)
 b2 = (Change in Y) / Change in lnX =
(Change in Y)/(Relative change in X) ~
(Y)/(X/X) (6.5.12)
 or Y = b2 (X/X) (6.5.13)
 That is, the absolute change in Y equal
to b2 times the relative change in X.
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Prof. Himayatullah May 2004
6-6. Reciprocal Models:
Log-lin and Lin-log Models

The reciprocal model:


 Yi = b1 + b2( 1/Xi ) + ui (6.5.14)
 As X increases definitely, the term
b2( 1/Xi ) approaches to zero and Yi
approaches the limiting or asymptotic value
b1 (See figure 6.5 in page 174)
 An Illustrative example: The Phillips Curve
for the United Kingdom 1950-1966

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Prof. Himayatullah May 2004
6-7. Summary of Functional Forms
Table 6.5 (page 178)

Model Equation Slope = Elasticity =


dY/dX (dY/dX).(X/Y)
Linear Y = b1 + b2 X b2 b2(X/Y) */

Log-linear lnY = b1 + b2 lnX b2 (Y/X) b2


(log-log)
Log-lin lnY = b1 + b2 X b2 (Y) b2 X */
Lin-log Y = b1 + b2 lnX b2(1/X) b2 (1/Y) */
Reciprocal Y = b1 + b2 (1/X) - b2(1/X2) - b2 (1/XY) */

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Prof. Himayatullah May 2004
6-7. Summary of Functional Forms
 Note: */ indicates that the elasticity
coefficient is variable, depending on the
value taken by X or Y or both. when no X
and Y values are specified, in practice, very
often these elasticities are measured at the
mean values E(X) and E(Y).
-----------------------------------------------
6-8. A note on the stochastic error term
6-9. Summary and conclusions
(pages 179-180)

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Prof. Himayatullah May 2004

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