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Multiple Linear Regression

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Corporate Finance Institute

Multiple Linear Regression


A statistical technique that is used to predict the outcome of a variable based on the value
of two or more variables

Home › Resources › Knowledge › Other › Multiple Linear Regression

What is Multiple Linear Regression?

Multiple linear regression refers to a statistical technique that is used to predict the outcome of a
variable based on the value of two or more variables. It is sometimes known simply as multiple
regression, and it is an extension of linear regression. The variable that we want to predict is
known as the dependent variable, while the variables we use to predict the value of
the dependent variable are known as independent or explanatory variables.

 
Figure 1: Multiple linear regression model predictions for individual observations (Source)

Summary

 Multiple linear regression refers to a statistical technique that uses two or more independent
variables to predict the outcome of a dependent variable.
 The technique enables analysts to determine the variation of the model and the relative
contribution of each independent variable in the total variance.
 Multiple regression can take two forms, i.e., linear regression and non-linear regression.

 
Multiple Linear Regression Formula

Where:

 yi is the dependent or predicted variable


 β0 is the y-intercept, i.e., the value of y when both xi and x2 are 0.
 β1 and β2 are the regression coefficients representing the change in y relative to a one-unit
change in xi1 and xi2, respectively.
 βp is the slope coefficient for each independent variable
 ϵ is the model’s random error (residual) term.

Understanding Multiple Linear Regression

Simple linear regression enables statisticians to predict the value of one variable using the
available information about another variable. Linear regression attempts to establish the
relationship between the two variables along a straight line.

Multiple regression is a type of regression where the dependent variable shows


a linear relationship with two or more independent variables. It can also be non-linear, where
the dependent and independent variables do not follow a straight line.

Both linear and non-linear regression track a particular response using two or more variables
graphically. However, non-linear regression is usually difficult to execute since it is created from
assumptions derived from trial and error.

Assumptions of Multiple Linear Regression

Multiple linear regression is based on the following assumptions:

 
1. A linear relationship between the dependent and independent variables

The first assumption of multiple linear regression is that there is a linear relationship between the
dependent variable and each of the independent variables. The best way to check the linear
relationships is to create scatterplots and then visually inspect the scatterplots for linearity. If the
relationship displayed in the scatterplot is not linear, then the analyst will need to run a non-
linear regression or transform the data using statistical software, such as SPSS.

2. The independent variables are not highly correlated with each other

The data should not show multicollinearity, which occurs when the independent variables
(explanatory variables) are highly correlated. When independent variables show
multicollinearity, there will be problems figuring out the specific variable that contributes to the
variance in the dependent variable. The best method to test for the assumption is the Variance
Inflation Factor method.

3. The variance of the residuals is constant

Multiple linear regression assumes that the amount of error in the residuals is similar at each
point of the linear model. This scenario is known as homoscedasticity. When analyzing the data,
the analyst should plot the standardized residuals against the predicted values to determine if the
points are distributed fairly across all the values of independent variables. To test the assumption,
the data can be plotted on a scatterplot or by using statistical software to produce a scatterplot
that includes the entire model.

4. Independence of observation

The model assumes that the observations should be independent of one another. Simply put, the
model assumes that the values of residuals are independent. To test for this assumption, we use
the Durbin Watson statistic.

The test will show values from 0 to 4, where a value of 0 to 2 shows positive autocorrelation, and
values from 2 to 4 show negative autocorrelation. The mid-point, i.e., a value of 2, shows that
there is no autocorrelation.

 
5. Multivariate normality

Multivariate normality occurs when residuals are normally distributed. To test this assumption,
look at how the values of residuals are distributed. It can also be tested using two main methods,
i.e., a histogram with a superimposed normal curve or the Normal Probability Plot method.

More Resources

Thank you for reading CFI’s guide to Multiple Linear Regression. To keep learning and
developing your knowledge base, please explore the additional relevant CFI resources below:

 Forecasting Methods
 Poisson Distribution
 Random Variable
 Regression Analysis

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