Introduction

 to  Econometrics  
(3rd  Updated  Edition, Global Edition)  

by  

James  H.  Stock  and  Mark  W.  Watson  

Solutions to Odd-Numbered End-of-Chapter Exercises:

Chapter 4
(This version August 17, 2014)

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 1
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4.1. (a) The predicted average test score is

� = 640.3 − 4.93× 25
TestScore = 517.05
(b) The predicted change in the classroom average test score is
�
∆ TestScore = −4.93(24 − 21) = −14.79

(c) Using the formula for ˆ 0 in Equation (4.8), we know the sample average of the test scores
across the 50 classrooms is
�0 + 𝛽𝛽
�𝑇𝑇�𝑇𝑇��𝑇𝑇��𝑇𝑇�𝑇𝑇��𝑇𝑇�𝑇𝑇��𝑇𝑇�𝑇𝑇� = 𝛽𝛽 �1 × �𝐶𝐶��𝑇𝑇� =
640.3 − 4.93(22.8) =
527.9

(d) Use the formula for the standard error of the regression (SER) in Equation (4.19) to get the
sum of squared residuals:
SSR = (n − 2)SER 2 = (50 − 2) × 8.7 2 = 3,633.12

Use the formula for R 2 in Equation (4.16) to get the total sum of squares:
SSR 3633.12 3633.12
=
TSS = = = 4,082.16
1 − R 2 1 − 0.11 0.89
TSS 4,082.16
The sample variance is=
SY2 = = 83.309. Thus, standard deviation is SY = 9.127.
n −1 49

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 2
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4.3. (a) The coefficient 9.6 shows the marginal effect of Age on AWE; that is, AWE is
expected to increase by $9.6 for each additional year of age. 696.7 is the intercept
of the regression line. It determines the overall level of the line.
(b) SER is in the same units as the dependent variable (Y, or AWE in this example).
Thus SER is measures in dollars per week.
(c) R2 is unit free.
(d) (i) 696.7 + 9.6 × 25 = $936.7;
(ii) 696.7 + 9.6 × 45 = $1,128.7
(e) No. The oldest worker in the sample is 65 years old. 99 years is far outside the
range of the sample data.
(f) No. The distribution of earning is positively skewed and has kurtosis larger
than the normal.
(g) βˆ0 = Y − βˆ1 X , so that Y = βˆ0 + βˆ1 X . Thus the sample mean of AWE is 696.7
+ 9.6 × 41.6 = $1,096.06.

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 3
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4.5. (a) ui represents factors other than time that influence the participant’s performance on the test
including inherent cognitive ability and aptitude. Some may have better memories than
others, and some might be worse.
(b) Because of random assignment ui is independent of Xi. Since ui represents deviations from
average E(ui) = 0. Because u and X are independent E(ui|Xi) = E(ui) = 0. If E(b0-hat) =
b0 and E(b1-hat)= b1 then the estimated coefficients are unbiased.
(c) Non-compliance is a concern because while the researcher can assign nap times
to individual participants, they cannot ensure that participants will sleep for the entire period
of time. However, if the sleep compliance is equally good (or bad) across both groups, non-
compliance will only reduce the precision of the estimates but will not introduce bias.
(d) (i) 55 + 0.17 × 60 = 65.2; 55 + 0.17 × 75 = 67.75; 55 + 0.17 × 90 = 70.3
(ii) 0.17 × 5 = 0.85

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 4
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4.7. The expectation of βˆ0 is obtained by taking expectations of both sides of Equation
(4.8):

⎡ ⎛⎜ 1 n ⎞⎟ ⎤
E ( βˆ0 ) = E (Y − βˆ1 X ) = E ⎢ ⎜ β 0 + β1 X + ∑ ui ⎟ − βˆ1 X ⎥
⎣ ⎜⎝ n i =1 ⎟⎠ ⎦
n
1
= β 0 + E ( β1 − βˆ1 ) X + ∑ E (ui )
n i =1
= β0
where the third equality in the above equation has used the facts that E(ui) = 0 and
E[( β̂1 −β1) X ] = E[(E( β̂1 −β1)| X ) X ] = because E[( β1 − βˆ1 ) | X ] = 0 (see text
equation (4.31).)

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 5
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4.9. (a) With βˆ1 = 0, βˆ0 = Y , and Yˆi = βˆ0 = Y . Thus ESS = 0 and R2 = 0.

(b) If R2 = 0, then ESS = 0, so that Yˆi = Y for all i. But Yˆi = βˆ0 + βˆ1 X i , so that Yˆi = Y

for all i, which implies that βˆ1 = 0, or that Xi is constant for all i. If Xi is constant

∑
n
for all i, then i −1
( X i − X )2 = 0 and β̂1 is undefined (see equation (4.7)).

©2015 Pearson Education, Ltd.

 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 6
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
n
4.11. (a) The least squares objective function is i 1
(Yi  b1 X i ) 2. Differentiating with respect to b1
n
  (Yi  b1 X i ) 2
 2 i 1 X i (Yi  b1 X i ). Setting this zero, and solving for the least
i 1 n
yields
b1
n

X Y i i
squares estimator yields ˆ1  i 1
n
.
 X i2
i 1

 X (Y  4) i i
(b) Following the same steps in (a) yields ˆ1  i 1
n
.
 X i2
i 1

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 4 7
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4.13. The answer follows the derivations in Appendix 4.3 in “Large-Sample Normal
Distribution of the OLS Estimator.” In particular, the expression for νi is now νi =
(Xi − µX)κui, so that var(νi) = κ3var[(Xi − µX)ui], and the term κ2 carry through the rest
of the calculations.

©2015 Pearson Education, Ltd.