Introductory Econometrics: A Modern Approach (7e)
Chapter 6
Multiple Regression Analysis: Further
Issues
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Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (1 of 16)
• More on Functional Form
• More on using logarithmic functional forms:
• Convenient percentage/elasticity interpretation
• Slope coefficients of logged variables are invariant to rescalings
• Taking logs often eliminates/mitigates problems with outliers
• Taking logs often helps to secure normality and homoskedasticity
• Variables measured in units such as years should not be logged
• Variables measured in percentage points should also not be logged
• Logs must not be used if variables take on zero or negative values
• It is hard to reverse the log-operation when constructing predictions
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password-protected website or school-approved learning management system for classroom use. 2
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (2 of 16)
• Using quadratic functional forms
• Example: Wage equation
• Marginal effect of experience
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password-protected website or school-approved learning management system for classroom use. 3
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (3 of 16)
• Wage maximum with respect to work experience
• Does this mean the return to
experience becomes negative after
24.4 years?
• Not necessarily. It depends on how
many observations in the sample lie to
the right of the turnaround point.
• In the given example, these are about
28% of the observations. There may be
a specification problem (e.g. omitted
variables).
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 4
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (4 of 16)
• Example: Effects of pollution on housing prices
• Does this mean that, at a low number of rooms, more rooms are
associated with lower prices?
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password-protected website or school-approved learning management system for classroom use. 5
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (5 of 16)
• Calculation of the turnaround point
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password-protected website or school-approved learning management system for classroom use. 6
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (6 of 16)
• Other possibilities
• Higher polynomials
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password-protected website or school-approved learning management system for classroom use. 7
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (7 of 16)
• Models with interaction terms
• Interaction effects complicate interpretation of parameters
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 8
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (8 of 16)
• Reparametrization of interaction effects
• Advantages of reparametrization
• Easy interpretation of all parameters
• Standard errors for partial effects at the mean values available
• If necessary, interaction may be centered at other interesting values
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 9
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (9 of 16)
• Average partial effects
• In models with quadratics, interactions, and other nonlinear
functional forms, the partial effect depend on the values of one or
more explanatory variables
• Average partial effect (APE) is a summary measure to describe the
relationship between dependent variable and each explanatory
variable
• After computing the partial effect and plugging in the estimated
parameters, average the partial effects for each unit across the
sample
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 10
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (10 of 16)
• More on goodness-of-fit and selection of regressors
• General remarks on R-squared
• A high R-squared does not imply that there is a causal interpretation
• A low R-squared does not preclude precise estimation of partial effects
• Adjusted R-squared
• What is the ordinary R-squared supposed to measure?
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 11
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (11 of 16)
• Adjusted R-squared (cont.)
• A better estimate taking into account degrees of freedom would be
• The adjusted R-squared imposes a penalty for adding new regressors
• The adjusted R-squared increases if, and only if, the t-statistic of a newly added
regressor is greater than one in absolute value
• Relationship between R-squared and adjusted R-squared
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 12
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (12 of 16)
• Using adjusted R-squared to choose between nonnested models
• Models are nonnested if neither model is a special case of the other
• A comparison between the R-squared of both models would be unfair
to the first model because the first model contains fewer parameters
• In the given example, even after adjusting for the difference in
degrees of freedom, the quadratic model is preferred
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 13
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (13 of 16)
• Comparing models with different dependent variables
• R-squared or adjusted R-squared must not be used to compare models which
differ in their definition of the dependent variable
• Example: CEO compensation and firm performance
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 14
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (14 of 16)
• Controlling for too many factors in regression analysis
• In some cases, certain variables should not be held fixed
• In a regression of traffic fatalities on state beer taxes (and other factors) one
should not directly control for beer consumption
• In a regression of family health expenditures on pesticide usage among farmers
one should not control for doctor visits
• Different regressions may serve different purposes
• In a regression of house prices on house characteristics, one would only include
price assessments if the purpose of the regression is to study their validity;
otherwise one would not include them
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 15
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (15 of 16)
• Adding regressors to reduce the error variance
• Adding regressors may excarcerbate multicollinearity problems
• On the other hand, adding regressors reduces the error variance
• Variables that are uncorrelated with other regressors should be added because
they reduce error variance without increasing multicollinearity
• However, such uncorrelated variables may be hard to find
• Example: Individual beer consumption and beer prices
• Including individual characteristics in a regression of beer consumption on beer
prices leads to more precise estimates of the price elasticity
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use. 16
Introductory Econometrics: A Modern Approach (7e)
Multiple Regression Analysis: Further Issues (16 of 16)
• Predicting y when log(y) is the dependent variable
• Under the additional assumption that u is independent of x1,...,xk:
© 2020 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
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