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2. mathematics
3. statistics

Economics 375: Introduction to Econometrics
Homework #4
This homework is due on February 28th.
1.
One tool to aid in understanding econometrics is the Monte Carlo experiment. A Monte
Carlo experiment allows a researcher to set up a known population regression function
(something we’ve assumed we can never observe) and then act like a normal econometrician,
forgetting for the moment the population regression function, and seeing how closely an OLS
estimate of the regression comes to the true and known population regression function.
Our experiment will demonstrate that OLS is unbiased (something that the Gauss Markov
Theorem should convince you of). The idea behind Monte Carlo experiments is to use the
computer to create a population regression function (which we usually think of as being
unobserved), then acting like we “forgot” the PRF, and using OLS to estimate the PRF. Thus, a
Monte Carlo experiment allows a researcher to understand if OLS actually comes “close” to the
PRF or not. In Stata, this is easy. Start by creating opening Stata and creating a new variable
titled x1. The easiest way to do this is to enter two commands in the command box without my
brackets {set obs 20} {gen x1 = _n in 1/20}. The first command tells stata that you are going to
use a data set with 20 observations. The second sets the value of x1 equal to the index number
(always starting at one and increasing by one for each observation). To create a random normal
variable type the following in the command line gen epsilon = rnormal(). This generates a new
series of 20 observations titled "epsilon" where each observation is a random draw from a normal
distribution with mean zero and variance one. In this case, gen represents the generate
command, epsilon is the name of a new variable you are creating that is a random draw from a
normal distribution. The generate command is a commonly used command in Stata. It might be
worth reading the help menu on this command (type: help generate in the command line).
After creating epsilon, we are ready to create our dependent variable y. To do this, let’s create a
population regression where we know the true slope and intercept of the regression. Since my
favorite football player was Dave Krieg of the Seattle Seahawks (#17) and my favorite baseball
player was Ryne Sandberg (#23), we will use these numbers to generate our dependent variable.
In Stata use the gen command to create y where:
yi = 17 + 23x1i + epsiloni
Your command will look something like: gen y = 17 + 23*x1 + epsilon
At this point, if you’ve done everything correctly, you should have data that looks something
like:
Using your created data, use Stata’s reg command to estimate the regression:
yi = B0 + B1x1i
a. Why didn’t you include epsilon in this regression?
Generally, econometricians do not observe the error term of any regression (if they did, they would not need to
estimate the regression since knowing the value of Y, X and the value of the error term would allow the
econometrician to perfectly observe the PRF).
b. What are your estimates of the true slope coefficients and intercept? Perform a hypothesis
test that B1 = 23. What do you find?
When I estimate my regression, I get:
. reg y x
Source
SS
df
MS
Model
Residual
352132.22
16.159413
1
18
352132.22
.897745166
Total
352148.379
19
18534.1252
y
Coef.
x1
_cons
23.01135
16.50865
Std. Err.
.0367422
.4401408
t
626.29
37.51
Number of obs
F( 1,
18)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
20
.
0.0000
1.0000
1.0000
.94749
P>|t|
[95% Conf. Interval]
0.000
0.000
22.93416
15.58395
23.08854
17.43335
Note: this will differ from what you obtained because my epsilon will differ from yours.
Ho: B1 = 23
Ha: B1 ≠ 23
t = (23.01135 – 23)/.0367422 = .308
tc,18,95% = 2.101
I fail to reject the null and conclude that I do not have enough evidence to state that the slope differs from 23.
c. When you turn this homework into me, I will ask the entire class to tell me their estimates of
the true, B0, and B1. I will then enter these estimates in a computer, order each from smallest to
largest, and then make a histogram of each estimate. What will this histogram look like? Why?
I performed 10,000 different experiments exactly as described above. I found:
It is pretty apparent that the estimates of B0 and B1 are normally distributed around the true population means of 17
and 23. The Gauss Markov theorem indicates that these distributions have the smallest variance—as long as our
classical assumptions are correct. Are they in this case?
Interestingly, when I performed this monte carlo experiment, I found the standard deviation of my 10,000 estimates
of B0 to equal .4612 and for B1 to equal .0386. For a moment, consider the variances of the slope and intercept we
discovered in class:
2
2
 ^  σ ∑ Xi
Var B 0  =
  n ∑ x i2
σ2
^ 
Var  B1  =
  ∑ x i2
In our data, the sum of the xi2 = 665. Since the variance of the regression is equal to 1 (by virtue of setting up
epsilon), the
1
^ 
Var B1  =
=.0015 and taking the square root gives the standard error of B1-hat of .0387—very
  665
close to the monte carlo estimate of .0386.
∑ d. Use Stata to compute . The square root of this is termed the “standard error of the
regression.” Does it equal what you would expect? Why or why not?
.
In my case = .897. In this case, my best guess at the variance of the (usually unknown) error term is
.897. Since we know that the variance is actually equal to one and that there may be sampling error when stata
draws from a distribution with variance equal to one, my estimates turn out well.
2.
On the class webpage, I have posted a Stata file entitled “2002 Freshmen Data” This data
is comprised of all complete observations of the 2002 entering class of WWU freshmen
(graduating class of around 2006). The data definitions are:
aa: a variable equal to one if the incoming student previously earned an AA
actcomp: the student’s comprehensive ACT score
acteng: the student’s English ACT score
actmath: the student’s mathematics ACT score
ai: the admissions index assigned by WWU office of admissions
asian, black, white, Hispanic, other, native: a variable equal to one if the student is that ethnicity
f03 and f04: a variable equal to one if the student was enrolled in the fall of 2003 or the fall of
2004
gpa: the student’s GPA earned at WWU in fall 2002
summerstart: a variable equal to one if the student attended summerstart prior to enrolling in
WWU
fig: a variable equal to one if the student enrolled in a FIG course
firstgen: a variable equal to one if the student is a first generation college student
housing: a variable equal to one if the student lived on campus their first year at WWU
hrstrans: the number of credits transferred to WWU at time of admission
hsgpa: the student’s high school GPA
male: a variable equal to one if the student is male
resident: a variable equal to one if the student is a Washington resident
runstart: a variable equal to one if the student is a running start student
satmath: the student’s mathematics SAT score
satverb: the student’s verbal SAT score
Some of these variables (the 0/1 or “dummy” variables) will be discussed in the future.
Admissions officers are usually interested in the relation between high school performance and
college performance. Consider the population regression function:
gpai = β0 + β1hsgpai + εi
a. Use the “2002 Freshmen Data” to estimate this regression. How do you interpret your
estimate of β1? Why does this differ from what you found in homework #3?
I find:
. reg gpa hsgpa
Source
SS
df
MS
Model
Residual
195.606722
860.667118
1
2079
195.606722
.413981298
Total
1056.27384
2080
.507823962
gpa
Coef.
hsgpa
_cons
1.001795
-.7431143
Std. Err.
.0460869
.1628574
t
21.74
-4.56
Number of obs
F( 1, 2079)
Prob > F
R-squared
Adj R-squared
Root MSE
P>|t|
0.000
0.000
=
=
=
=
=
=
2081
472.50
0.0000
0.1852
0.1848
.64341
[95% Conf. Interval]
.9114138
-1.062495
1.092176
-.4237337
A unit increase in high school GPA increases college GPA by 1.001 units.
H0: β1 = 0
HA: β1 ≠ 0
t = (1.001 – 0)/.046 = 21.74
tc,95%,2161= 1.96
Reject H0 and conclude that high school GPA does impact college GPA.
b. When I was in high school, my teachers told me to expect, on average, to earn one grade
lower in college than what I averaged in high school. Based on the results of your regression,
would you agree with my teachers?
If my teachers were correct, then the population regression function would be Fall02GPAi = -1 + 1×HSGPAi + εi.
Note, that only under this population regression function would students earning any hsgpa would end up having
exactly a one unit lower college gpa.
At first glance, one might look at our regression estimates and quickly conclude that the intercept is not equal to -1
so my teachers were incorrect. However, our estimated intercept of -.79 is an estimate; how likely does -.79 result
when the true intercept is -1 is a question that can only be answered using a hypothesis test:
H0 : β0 = -1
HA : β0 ≠ -1
t = (-.74 - -1)/.162 = 1.59
tc,95%,2077 = 1.96
I would fail to reject this hypothesis and conclude that my intercept is statistically no different than -1 which is what
I would need for my college GPA to be one unit less than my high school GPA.
However, this too would be an incorrect approach as it only tests one of the two needed requirements (note, the
slope must equal one AND the intercept must equal -1). What I really need to test is:
H0 : β0 = -1 & β1 = 1
HA : (β0 ≠ -1 & β1 ≠ 1) or (β0 = -1 & β1 ≠ 1) or (β0 ≠ -1 & β1 = 1)
In this case, the alternative hypothesis simply states all of the options not included in the null hypothesis.
To test this, let us impose the null hypothesis: Fall02GPAi = -1 + 1×HSGPAi + εi.. This statement is something that
I cannot estimate, after all there are no coefficients in it. However, if the null hypothesis is true, then it must be that
Fall02GPAi +1 - HSGPAi = εi. If we square both sides and add them up, then I will have a restricted residual sum of
squares. I obtain this in stata by:
. gen restresid = gpa +1 - hsgpa
(33 missing values generated)
. gen restresid2 = restresid^2
(33 missing values generated)
. total restresid2
Total estimation
Number of obs
Total
restresid2
1004.833
=
2081
Std. Err.
[95% Conf. Interval]
30.02165
945.9573
I can produce an f-test using this information: F =
1063.708
(.
.)/
./(
)
=174.12
Fc,2,2079 ≈3.00
In this case, I reject the null hypothesis and conclude my high school teachers were wrong.
c. Now, consider the multivariate regression:
GPA = β0 + β1hsgpa + β2SatVerb + β3SatMath+ β4Runningstart+ β5Fig+ β6FirstGen
d. What is your estimate of β1? How do you interpret your estimate of β1? Why does this differ
from what you found in homework #3?
I find:
174.12142
. reg gpa hsgpa satverb satmath runningstart fig firstgen
Source
SS
df
MS
Model
Residual
288.775092
767.498748
6
2074
48.129182
.370057256
Total
1056.27384
2080
.507823962
gpa
Coef.
hsgpa
satverb
satmath
runningstart
fig
firstgen
_cons
.8877086
.0021184
.0006516
-.0800822
.2122322
-.0498571
-1.867454
Std. Err.
.044665
.0001952
.000203
.036424
.0386718
.0286369
.1747998
t
19.87
10.86
3.21
-2.20
5.49
-1.74
-10.68
Number of obs
F( 6, 2074)
Prob > F
R-squared
Adj R-squared
Root MSE
P>|t|
=
=
=
=
=
=
2081
130.06
0.0000
0.2734
0.2713
.60832
[95% Conf. Interval]
0.000
0.000
0.001
0.028
0.000
0.082
0.000
.8001157
.0017357
.0002536
-.1515137
.1363926
-.1060172
-2.210255
.9753015
.0025012
.0010496
-.0086507
.2880718
.006303
-1.524652
.
In this case, the coefficient on hsgpa tells me that an increase in high school gpa of one unit increases college gpa by
.887 units, holding SAT scores, running start, fig participation and first generation status constant. This last phrase
(holding…) is important because it recognizes that the impact of high school gpa on college gpa has been purged of
the impact of these other variables. It is for this reason that it differs from the estimates you found in part a.
e. Test to see if the variables hsgpa, SatVerb, SatMath, Runningstart, Fig and FirstGen predict a
significant amount of the variation in WWU first quarter GPA.
Ho : β1 = β2 = β3 = β4 = β5 = β6 = 0 ↔ R2 = 0
Ho : R2 ≠ 0
This requires an F-test where the restricted model forces the null hypothesis to be true—that is it forces all slope
coefficients to be equal to zero. I can do that in stata by:
. reg gpa
Source
SS
df
MS
Model
Residual
0
1056.27384
0
2080
.
.507823962
Total
1056.27384
2080
.507823962
gpa
Coef.
_cons
2.783631
My F-statistic is
Std. Err.
.0156214
(.
.)/
./(
)
t
178.19
Number of obs
F( 0, 2080)
Prob > F
R-squared
Adj R-squared
Root MSE
=
=
=
=
=
=
2081
0.00
.
0.0000
0.0000
.71262
P>|t|
[95% Conf. Interval]
0.000
2.752996
2.814266
=130.06
My Fc,95%,6,2074 ≈ 2.10
I reject the null and conclude that hsgpa, satverb, satmath, runningstart, fig, and firstgen statistically explain some of
the variation in college gpa. Said another way, I conclude R2 is not zero.
Note the F-statistic I find is exactly the same one Stata reports in the second line of the right column above the
regression results.
f. Does SatVerb and SatMath predict WWU first quarter GPA? Test this!
This is equivalent to testing
Ho : β2 = β3 = 0
Ho : (β2 = 0 & β3 ≠ 0) or (β2 ≠ 0 & β3 = 0) or (β2 ≠ 0 & β3 ≠ 0)
My restricted regression is:
130.06244
. reg gpa hsgpa runningstart fig firstgen
Source
SS
df
MS
Model
Residual
211.95788
844.31596
4
2076
52.98947
.406703256
Total
1056.27384
2080
.507823962
gpa
Coef.
hsgpa
runningstart
fig
firstgen
_cons
1.014023
-.0180178
.1766598
-.1303211
-.7631823
My f-statistic is
Std. Err.
.0457579
.0379149
.0403859
.0294277
.1623353
(.
.)/
./(
)
t
22.16
-0.48
4.37
-4.43
-4.70
Number of obs
F( 4, 2076)
Prob > F
R-squared
Adj R-squared
Root MSE
P>|t|
0.000
0.635
0.000
0.000
0.000
=
=
=
=
=
=
2081
130.29
0.0000
0.2007
0.1991
.63773
[95% Conf. Interval]
.9242872
-.092373
.0974587
-.188032
-1.081539
1.103759
.0563375
.2558609
-.0726103
-.4448252
= 103.79
Fc,95%,2,2074 ≈ 3.00
I reject the null hypothesis and conclude that satverb and satmath do predict fall quarter college GPA.
g. Offer two reasons why the coefficient on runningstart is negative. Is this coefficient
statistically different than zero? Is it “economically” important?
From the full regression, I would reject the null hypothesis that the runninstart coefficient is zero at the 10%, but not
the 5% level. For the moment, let us say that the 10% level is an acceptable rejection level for our purposes. If this
is the case, then I conclude that students in the running start program do worse as freshmen than those entering as
traditional students. Why might this be? There are a large number of reasons. Here I offer a few:
1. It might be that running start students enroll in more difficult courses their fall quarter (perhaps thinking that they
are prepared for them given their prior history);
2. Running start students may be worse students than traditional students in some ways unmeasured by the included
independent variables.