Summer 2017 Examination

EC220
Introduction to Econometrics

2016/2017 syllabus – not for resit candidates

Instructions to candidates

This paper contains THREE questions. Answer all. Each question will be given equal weight.
There are 99 marks available for this exam. The mark you achieve in the exam will be converted
into a percentage and weighted accordingly when calculating the overall grades for the course.
Time allowed: Reading Time: None
Writing Time: 2 hours

You are supplied with: Murdoch & Barnes Statistical Tables (4th ed.)
Table A5 Durbin-Watson d-statistic

You may also use: No additional material

Calculators: Calculators are allowed in this examination.

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1. Consider the bivariate regression model without intercept

yi = xi + ui ;

for i = 1; : : : ; n. We impose the following assumptions.

SLR.1 The population model is y = x + u.

SLR.2 We have a random sample of size n, f(yi ; xi ) : i = 1; : : : ; ng, following the population
model in SLR.1.
SLR.3 The sample outcomes onfxi : i = 1; : : : ; ng are not all the same value.
SLR.4 The error term u satisfies E(ujx) = 0 for any value of x.
SLR.5 The error term u satisfies V ar(ujx) = 2 for any value of x (homoskedasticity).

(a) Show that the method of moments estimator of ; obtained by using E[xi ui ] = 0; is
written as Pn
^ = Pi=1 xi yi :
n 2
i=1 xi
In your answer clearly indicate what a method of moments estimator is. (6 marks)

(b) Under SLR.1-5, derive the (conditional) variance V ar( ^ jX). (4 marks)

(c) You are concerned about the presence of heteroskedasticity. Under SLR.1-4, derive
V ar( ^ jX). Clearly indicate what you understand by the term heteroskedasticity.
. . (5 marks)

(d) Under SLR.1-4, prove that ^ is consistent for . (5 marks)

(e) Now, consider the following estimator

~ = y2 y1
;
x2 x1
which uses only two observations, (y1 ; x1 ) and (y2 ; x2 ).

i. Under SLR.1-5, derive E( ~ jX). Is this estimator unbiased? (4 marks)

ii. Under SLR.1-5, derive V ar( ~ jX). (4 marks)

(f) Compare ^ and ~ in terms of efficiency and consistency. Explain these concepts
clearly. (5 marks)

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2. (a) Consider the following regression model
1
yi = 0 + 1 + ui ;
xi
for i = 1; : : : ; 24. The OLS slope estimate is ^ 1 = 0:31 and its standard error is 0:082.
i. Test the hypothesis that the slope parameter 1 is 0:5 against the alternative that
it is not, at the 5% level of significance. State the assumptions to validate the
proposed test. (5 marks)

ii. Explain how to compute the p-value for the two-sided test of the hypothesis that
the slope is zero. Draw a sketch to illustrate. (5 marks)

iii. Suppose you know that the error term ui is heteroskedastic and satisfies V ar(ui jxi ) =
2 =x2 for i = 1; : : : ; 24. Discuss how you would obtain the best linear unbiased
i
estimator (BLUE) of 1 (note, you are not asked to derive this estimator). Give two
reasons why you would prefer using the BLUE for 1 instead of the OLS estimator.
. . (7 marks)

(b) Consider the following non-stationary process

yt = 0 + 1t + ut , with ut = ut 1 + "t

and "t i.i.d. 0; 2 :

i. Indicate (with explanation) the source(s) of non-stationarity of yt : (2 marks)

ii. Show that you can rewrite the model as

yt = 0 + 1t + 2 yt 1 + "t : (2.1)

Clearly indicate the one-to-one relation between ( 0; 1; ) and ( 0; 1; 2 ).

. . (4 marks)

iii. What name do we give the non-stationary process yt when = 1? Indicate how
you would test whether indeed = 1. Clearly indicate the alternative, the test
statistic and the rejection rule. (5 marks)

iv. Assuming we reject the hypothesis in (b)iii., is it reasonable to expect that your
OLS parameter estimates of the ’s in (2.1) are unbiased and/or consistent. Explain
your reasoning.
. . (5 marks)

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3. Let us consider an analysis on recidivism (probability of re-arrest) among a group of young
men in California who have at least one arrest prior to 1986. The dependent variable, arr86,
is equal to unity if the man was arrested at least once during 1986, and zero otherwise.

OLS Logit Logit

Marginal Effect
pcnv :162 :901 :176
(:021) (:120) (:023)
avgsen :006 :031 :006
(:006) (:034) (:007)
tottime :002 :010 :002
(:005) (:027) (:005)
ptime86 :022 :127 :025
(:005) (:031) (:006)
qemp86 :043 :216 :042
(:005) (:028) (:005)
constant :380 :169
(:019) (:084)
R2 :047
log L 1541:24

pcnv is the proportion of prior arrests that led to a conviction, avgsen is the average
sentence served from prior convictions, tottime is the months spent in prison since age 18
prior to 1986, ptime86 is months spent in prison in 1986, qemp86 is the number of quarters
the man was legally employed in 1986. The standard errors are reported in parentheses.

(a) Using the OLS results, what is the estimated effect on the probability of arrest if pcnv
goes from 0.25 to 0.75 holding everything else constant? (5 marks)

(b) It is argued that the linear probability model is not appropriate for explaining the binary
variable rr86 and a logit regression model has been estimated. Explain clearly how
the Logit estimates are obtained. (8 marks)

Hint: You may recall, that for the Logit model, we will specify

Pr(arr86i = 1) = ( 0 + 1 pcnv + 2 avgsen + ::: + 5 qemp86)

exp(z)
where (z) = 1+exp(z) .

. .(question continues on next page)

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 (c) The F test is commonly used when testing the joint significance of the slopes when
using OLS.

i. Why might you want to propose a robust version of this test when using OLS to
estimate this LPM? You are not asked to indicate how to do this! (5 marks)

ii. Discuss how you would test the joint significance of the slopes when using the
Logit model. Clearly indicate what additional information you would need. Provide
the test statistic and rejection rule. (5 marks)

(d) An important distinction between the two approaches is that the marginal effect of
pcnv on the probability of re-arrest is constant for the LPM unlike the marginal effect
using the logit analysis. What this means for instance is that the estimated effect
on the probability of arrest if pcnv goes from 0.25 to 0.75 will depend on the other
characteristics.

i. Explain how the marginal effects evaluated at the mean values of the explanatory
variables (reported in the last column) were obtained. Give a brief comment as to
how they compare to the marginal effect of the associated LPM. (5 marks)

ii. What limitations do you see with the marginal effects obtained in (d)i.? Suggest
an alternative that does not suffer from these limitations. How would you interpret
your suggestion? (5 marks)

. .END OF PAPER

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