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Example of How To Use Multiple Linear Regression

Multiple linear regression allows prediction of a dependent variable based on the values of two or more independent variables. It determines the mathematical relationship between a dependent variable (like stock price) and multiple explanatory variables (like market index, oil price, interest rates). The model finds coefficients that best fit a linear equation to the data. While more predictive than simple regression, multiple regression still may not perfectly predict outcomes due to variation between predicted and actual values.

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Deepak Padiyar
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93 views

Example of How To Use Multiple Linear Regression

Multiple linear regression allows prediction of a dependent variable based on the values of two or more independent variables. It determines the mathematical relationship between a dependent variable (like stock price) and multiple explanatory variables (like market index, oil price, interest rates). The model finds coefficients that best fit a linear equation to the data. While more predictive than simple regression, multiple regression still may not perfectly predict outcomes due to variation between predicted and actual values.

Uploaded by

Deepak Padiyar
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Example of How to Use Multiple Linear Regression

As an example, an analyst may want to know how the movement of the


market affects the price of ExxonMobil (XOM). In this case, their linear
equation will have the value of the S&P 500 index as the independent
variable, or predictor, and the price of XOM as the dependent variable.

In reality, multiple factors predict the outcome of an event. The price


movement of ExxonMobil, for example, depends on more than just the
performance of the overall market. Other predictors such as the price of
oil, interest rates, and the price movement of oil futures can affect the price
of XOM and stock prices of other oil companies. To understand a
relationship in which more than two variables are present, multiple linear
regression is used.

Multiple linear regression (MLR) is used to determine a mathematical


relationship among several random variables.1 In other terms, MLR
examines how multiple independent variables are related to one
dependent variable. Once each of the independent factors has been
determined to predict the dependent variable, the information on the
multiple variables can be used to create an accurate prediction on the level
of effect they have on the outcome variable. The model creates a
relationship in the form of a straight line (linear) that best approximates all
the individual data points.

Referring to the MLR equation above, in our example:

 yi = dependent variable—the price of XOM


 xi1 = interest rates
 xi2 = oil price
 xi3 = value of S&P 500 index
 xi4= price of oil futures
 B0 = y-intercept at time zero
 B1 = regression coefficient that measures a unit change in the
dependent variable when xi1 changes - the change in XOM price
when interest rates change
 B2 = coefficient value that measures a unit change in the dependent
variable when xi2 changes—the change in XOM price when oil prices
change

The least-squares estimates—B0, B1, B2…Bp—are usually computed by


statistical software. As many variables can be included in the regression
model in which each independent variable is differentiated with a
number—1,2, 3, 4...p. The multiple regression model allows an analyst to
predict an outcome based on information provided on multiple explanatory
variables.

Still, the model is not always perfectly accurate as each data point can
differ slightly from the outcome predicted by the model. The residual value,
E, which is the difference between the actual outcome and the predicted
outcome, is included in the model to account for such slight variations.

Assuming we run our XOM price regression model through a statistics


computation software, that returns this output:

What Multiple Linear Regression Can Tell You


Simple linear regression is a function that allows an analyst or statistician
to make predictions about one variable based on the information that is
known about another variable. Linear regression can only be used when
one has two continuous variables—an independent variable and a
dependent variable. The independent variable is the parameter that is
used to calculate the dependent variable or outcome. A multiple regression
model extends to several explanatory variables.

The multiple regression model is based on the following assumptions:

 There is a linear relationship between the dependent variables and


the independent variables
 The independent variables are not too highly correlated with each
other
 yi observations are selected independently and randomly from the
population
 Residuals should be normally distributed with a mean of 0
and variance σ

The coefficient of determination (R-squared) is a statistical metric that is


used to measure how much of the variation in outcome can be explained
by the variation in the independent variables. R 2 always increases as more
predictors are added to the MLR model, even though the predictors may
not be related to the outcome variable.

R2 by itself can't thus be used to identify which predictors should be


included in a model and which should be excluded. R 2 can only be
between 0 and 1, where 0 indicates that the outcome cannot be predicted
by any of the independent variables and 1 indicates that the outcome can
be predicted without error from the independent variables.
When interpreting the results of multiple regression, beta coefficients are
valid while holding all other variables constant ("all else equal"). The output
from a multiple regression can be displayed horizontally as an equation, or
vertically in table form.

Example of How to Use Multiple Linear Regression


As an example, an analyst may want to know how the movement of the
market affects the price of ExxonMobil (XOM). In this case, their linear
equation will have the value of the S&P 500 index as the independent
variable, or predictor, and the price of XOM as the dependent variable.

In reality, multiple factors predict the outcome of an event. The price


movement of ExxonMobil, for example, depends on more than just the
performance of the overall market. Other predictors such as the price of
oil, interest rates, and the price movement of oil futures can affect the price
of XOM and stock prices of other oil companies. To understand a
relationship in which more than two variables are present, multiple linear
regression is used.

Multiple linear regression (MLR) is used to determine a mathematical


relationship among several random variables.1 In other terms, MLR
examines how multiple independent variables are related to one
dependent variable. Once each of the independent factors has been
determined to predict the dependent variable, the information on the
multiple variables can be used to create an accurate prediction on the level
of effect they have on the outcome variable. The model creates a
relationship in the form of a straight line (linear) that best approximates all
the individual data points.

Referring to the MLR equation above, in our example:

 yi = dependent variable—the price of XOM


 xi1 = interest rates
 xi2 = oil price
 xi3 = value of S&P 500 index
 xi4= price of oil futures
 B0 = y-intercept at time zero
 B1 = regression coefficient that measures a unit change in the
dependent variable when xi1 changes - the change in XOM price
when interest rates change
 B2 = coefficient value that measures a unit change in the dependent
variable when xi2 changes—the change in XOM price when oil prices
change
The least-squares estimates—B0, B1, B2…Bp—are usually computed by
statistical software. As many variables can be included in the regression
model in which each independent variable is differentiated with a
number—1,2, 3, 4...p. The multiple regression model allows an analyst to
predict an outcome based on information provided on multiple explanatory
variables.

Still, the model is not always perfectly accurate as each data point can
differ slightly from the outcome predicted by the model. The residual value,
E, which is the difference between the actual outcome and the predicted
outcome, is included in the model to account for such slight variations.

Assuming we run our XOM price regression model through a statistics


computation software, that returns this output:

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