Basic Business Statistics

12th Edition

Chapter 1

Simple Linear Regression

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-1
 Learning Objectives
In this chapter, you learn:
 How to use regression analysis to predict the value of
a dependent variable based on an independent
variable
 The meaning of the regression coefficients b0 and b1
 How to evaluate the assumptions of regression
analysis and know what to do if the assumptions are
violated
 To make inferences about the slope and correlation
coefficient
 To estimate mean values and predict individual values
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-2
 Economic models and the need
for econometrics

Three basic questions that have to be answered during the

analysis:
1.Which (economic) relationships could be / are \known" to
be relevant for this question?
2.Which data can be useful for checking the possibly
relevant economic conjectures /theories?
3.How to decide about which economic conjecture to reject
or to follow?

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-3
 Economic models and the need
for econometrics

An economic model:
 Has to reduce the complexity of reality such that it is
useful for answering the question of interest;
 is a collection of cleverly chosen assumptions from
which implications can be inferred (using logic) |
Example: Heckscher-Ohlin model;
 should be as simple as possible and as complex as
necessary;
 cannot be refuted or \validated" without empirical data
of some kind.

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-4
 Economic models and the need
for econometrics

 Standard problems of economic models:

- The conjectured economic model is likely to neglect
some factors,
- Numeric results to the numerical questions posed
depend in general choice of a data set, a different data
set leads to different numerical results
=> Numeric answers always have some uncertainty.

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-5
 Economic models and the need
for econometrics

 Econometrics
- offers solutions for dealing with unobserved factors in
economic models,
- provides \both a numerical answer to the question and a
measure how precise the answer is,
- provides tools that allow to refute economic hypotheses
using statistical techniques by confronting theory with
data and to quantify the probability of such decisions to
be wrong,
- allows to quantify risks of forecasts, decisions, and
even of its own analysis.
Copyright ©2012 Pear son Education, Inc. publishing as Prentice Hall Chap 13-6
 Economic models and the need
for econometrics

 Therefore:
Econometrics can also be useful for providing answers to
questions like:
- How reliable are predicted growth rates or returns?

- How likely is it that the value realizing in the future will

be close to the predicted value? In other words, how

precise are the predictions?
 Main tool: linear regression model

It allows to quantify the effect of a change in one

variable on another variable, holding other things constant
(ceteris paribus analysis).
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-7
 Steps of an econometric analysis:

1.Careful formulation of question/problem/task of interest.

2.Specification of an economic model.
3.Careful selection of a class of econometric models.
4.Collecting data.
5.Selection and estimation of an econometric model.
6.Diagnostics of correct model specification.
7.Usage of the model.
Note that there exists a large variety of econometric
models and model choice depends very much on the
research question, the underlying economic theory,
availability of data, and the structure of the problem.
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-8
 Some Definitions of Econometrics

 “… discover empirical relation between economic variables,

provide forecast of various economic quantities of interest ... (First
issue of volume 1, E conometrica, 1933)."
 “The science of model building consists of a set of quantitative
tools which are used to construct and then test mathematical
representations of the real world. The development and use of
these tools are subsumed under the subject heading of
econometrics Pindyck and Rubinfeld(1998).“
 Econometrics is based upon the development of statistical methods
for estimating economic relationships, testing economic theories,
and evaluating and implementing government and business policy
(Wooldridge,2009, p. 1)."

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-9
 Summary of tasks for econometric
methods
In brief: econometrics can be useful whenever you
encounter (economic) data and you want to make sense
out of them.
In detail:
∗ Providing a formal framework for falsifying postulated
economic relationships by confronting economic theory with
economic data using statistical methods: Economic
hypotheses are formulated and statistically tested on basis of
adequately (and repeatedly) collected data such that test
results may falsify the postulated hypotheses.
∗ Analyzing the effects of policy measures.
∗ Forecasting.

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-10
 Correlation vs. Regression
DCOVA
 A scatter plot can be used to show the
relationship between two variables
 Correlation analysis is used to measure the
strength of the association (linear relationship)
between two variables
 Correlation is only concerned with strength of the
relationship
 No causal effect is implied with correlation.

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-11
 Introduction to
Regression Analysis
DCOVA
 Regression analysis is used to:
 Predict the value of a dependent variable based on
the value of at least one independent variable
 Explain the impact of changes in an independent
variable on the dependent variable
Dependent variable: the variable we wish to
predict or explain
Independent variable: the variable used to predict
or explain the dependent
variable

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-12
 Simple Linear Regression
Model
DCOVA
 Only one independent variable, X
 Relationship between X and Y is
described by a linear function
 Changes in Y are assumed to be related
to changes in X

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-13
 Types of Relationships
DCOVA

Linear relationships Curvilinear relationships

Y Y

X X

Y Y

X X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-14
 Types of Relationships DCOVA
(continued)
Strong relationships Weak relationships

Y Y

X X

Y Y

X X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-15
 Types of Relationships DCOVA
(continued)
No relationship

X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-16
 Simple Linear Regression
Model
DCOVA

Population Random
Population Independent Error
Slope
Y intercept Variable term
Coefficient
Dependent
Variable

Yi  β0  β1Xi  ε i
Linear component Random Error
component

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-17
 Simple Linear Regression
Model DCOVA
(continued)

Y Yi  β0  β1Xi  ε i
Observed Value
of Y for Xi

εi Slope = β1
Predicted Value Random Error
of Y for Xi
for this Xi value
Intercept = β0

Xi X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-18
 Simple Linear Regression
Equation (Prediction Line) DCOVA
The simple linear regression equation provides an
estimate of the population regression line

Estimated
(or predicted) Estimate of Estimate of the
Y value for the regression regression slope
observation i intercept

Value of X for
observation i
Ŷi  b0  b1Xi

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-19
 The Least Squares Method
DCOVA
b0 and b1 are obtained by finding the values of
that minimize the sum of the squared
differences between Y and Ŷ :

2 2
min  (Yi Ŷi )  min  (Yi  (b0  b1Xi ))

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-20
 Finding the Least Squares
Equation

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-21
 Finding the Least Squares
Equation

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-22
 Finding the Least Squares
Equation
DCOVA

 The coefficients b0 and b1 , and other

regression results in this chapter, will be
found using Excel or Minitab

Formulas are shown in the text for those

who are interested

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-23
 Interpretation of the
Slope and the Intercept
DCOVA

 b0 is the estimated mean value of Y

when the value of X is zero

 b1 is the estimated change in the mean

value of Y as a result of a one-unit
increase in X

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-24
 Example

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-25
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-26
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-27
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-28
 Simple Linear Regression
Example DCOVA

 A real estate agent wishes to examine the

relationship between the selling price of a home
and its size (measured in square feet)

 A random sample of 10 houses is selected

 Dependent variable (Y) = house price in $1000s

 Independent variable (X) = square feet

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-29
 Simple Linear Regression
Example: Data DCOVA

House Price in $1000s Square Feet

(Y) (X)
245 1400
312 1600
279 1700
308 1875
199 1100
219 1550
405 2350
324 2450
319 1425
255 1700

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-30
 Simple Linear Regression
Example: Scatter Plot
DCOVA
House price model: Scatter Plot
450
400
House Price ($1000s)

350
300
250
200
150
100
50
0
0 500 1000 1500 2000 2500 3000
Square Feet

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-31
 Simple Linear Regression Example:
Using Excel Data Analysis Function
DCOVA
1. Choose Data 2. Choose Data Analysis

3. Choose Regression

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-32
 Simple Linear Regression Example:
Using Excel Data Analysis Function
(continued)
Enter Y’s and X’s and desired options
DCOVA

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-33
 Simple Linear Regression
Example: Using PHStat2
Add-Ins: PHStat2: Regression: Simple Linear Regression

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap

Chap 13-34
13-34
 Simple Linear Regression Example:
Excel Output
DCOVA
Regression Statistics
Multiple R 0.76211 The regression equation is:
R Square 0.58082
Adjusted R Square 0.52842 house price  98.24833  0.10977 (square feet)
Standard Error 41.33032
Observations 10

ANOVA
df SS MS F Significance F
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-35
 Simple Linear Regression
Example: Minitab Output
DCOVA
The regression equation is The regression
equation is:
Price = 98.2 + 0.110 Square Feet
house price = 98.24833 +
Predictor Coef SE Coef T P
0.10977 (square feet)
Constant 98.25 58.03 1.69 0.129
Square Feet 0.10977 0.03297 3.33 0.010

S = 41.3303 R-Sq = 58.1% R-Sq(adj) = 52.8%

Analysis of Variance

Source DF SS MS F P
Regression 1 18935 18935 11.08 0.010
Residual Error 8 13666 1708
Total 9 32600

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-36
 Simple Linear Regression Example:
Graphical Representation
DCOVA
House price model: Scatter Plot and Prediction Line
450
400
House Price ($1000s)

350 Slope
300
250
= 0.10977
200
150
100
50
Intercept 0
= 98.248 0 500 1000 1500 2000 2500 3000
Square Feet

house price  98.24833  0.10977 (square feet)

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-37
 Simple Linear Regression
Example: Interpretation of bo
DCOVA

house price  98.24833  0.10977 (square feet)

 b0 is the estimated mean value of Y when the

value of X is zero (if X = 0 is in the range of
observed X values)
 Because a house cannot have a square footage
of 0, b0 has no practical application

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-38
 Simple Linear Regression
Example: Interpreting b1 DCOVA

house price  98.24833  0.10977 (square feet)

 b1 estimates the change in the mean

value of Y as a result of a one-unit
increase in X
 Here, b1 = 0.10977 tells us that the mean value of a
house increases by .10977($1000) = $109.77, on
average, for each additional one square foot of size

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-39
 Simple Linear Regression
Example: Making Predictions
DCOVA
Predict the price for a house
with 2000 square feet:

house price  98.24833  0.10977 (sq.ft.)

 98.24833  0.10977(2000)
 317.78

The predicted price for a house with 2000

square feet is 317.78($1,000s) = $317,780
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-40
 Simple Linear Regression
Example: Making Predictions
DCOVA
 When using a regression model for prediction,
only predict within the relevant range of data
Relevant range for
interpolation
450
400
House Price ($1000s)

350
300
250
200
150
100
50 Do not try to
0
extrapolate
0 500 1000 1500 2000 2500 3000
Square Feet
beyond the range
of observed X’s
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-41
 Measures of Variation
DCOVA
 Total variation is made up of two parts:

SST  SSR  SSE

Total Sum of Regression Sum Error Sum of
Squares of Squares Squares

SST   ( Yi  Y )2 SSR   ( Ŷi  Y )2 SSE   ( Yi  Ŷi )2

where:
Y = Mean value of the dependent variable
Yi = Observed value of the dependent variable
Yˆi = Predicted value of Y for the given Xi value
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-42
 Measures of Variation
(continued)

DCOVA
 SST = total sum of squares (Total Variation)
 Measures the variation of the Yi values around their
mean Y
 SSR = regression sum of squares (Explained Variation)
 Variation attributable to the relationship between X
and Y
 SSE = error sum of squares (Unexplained Variation)
 Variation in Y attributable to factors other than X

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-43
 Measures of Variation
(continued)

DCOVA
Y
Yi  
SSE = (Yi - Yi )2 Y
_
SST = (Yi - Y)2

Y  _
_ SSR = (Yi - Y)2 _
Y Y

Xi X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-44
 Coefficient of Determination, r2
DCOVA
 The coefficient of determination is the portion
of the total variation in the dependent variable
that is explained by variation in the
independent variable
 The coefficient of determination is also called
r-squared and is denoted as r2

2SSR regression sum of squares

r  
SST total sum of squares

2
note:
0 r 1
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-45
 Examples of Approximate
r2 Values
DCOVA
Y
r2 = 1

Perfect linear relationship

between X and Y:
X
r2 = 1
Y 100% of the variation in Y is
explained by variation in X

X
r2 =1
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-46
 Examples of Approximate
r2 Values
DCOVA
Y
0 < r2 < 1

Weaker linear relationships

between X and Y:
X
Some but not all of the
Y
variation in Y is explained
by variation in X

X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-47
 Examples of Approximate
r2 Values
DCOVA

r2 = 0
Y
No linear relationship
between X and Y:

The value of Y does not

X depend on X. (None of the
r2 = 0
variation in Y is explained
by variation in X)

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-48
 Simple Linear Regression Example:
Coefficient of Determination, r2 in Excel
DCOVA
Regression Statistics SSR 18934.9348
2
r    0.58082
Multiple R 0.76211 SST 32600.5000
R Square 0.58082
Adjusted R Square 0.52842 58.08% of the variation in
Standard Error 41.33032 house prices is explained by
Observations 10
variation in square feet
ANOVA
df SS MS F Significance F
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-49
 Simple Linear Regression Example:
Coefficient of Determination, r2 in Minitab
DCOVA

The regression equation is

Price = 98.2 + 0.110 Square Feet

Predictor Coef SE Coef T P

Constant 98.25 58.03 1.69 0.129
Square Feet 0.10977 0.03297 3.33 0.010

S = 41.3303 R-Sq = 58.1% R-Sq(adj) = 52.8%

SSR 18934.9348
Analysis of Variance r2    0.58082
SST 32600.5000
Source DF SS MS F P
Regression 1 18935 18935 11.08 0.010 58.08% of the variation in
Residual Error 8 13666 1708 house prices is explained
Total 9 32600 by variation in square feet

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-50
 Standard Error of Estimate
DCOVA
 The standard deviation of the variation of
observations around the regression line is
estimated by
n
 (Yi  Yˆi ) 2
SSE i 1
S YX  
n2 n2
Where
SSE = error sum of squares
n = sample size

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-51
 Simple Linear Regression Example:
Standard Error of Estimate in Excel
DCOVA
Regression Statistics
Multiple R 0.76211 S YX  41.33032
R Square 0.58082
Adjusted R Square 0.52842
Standard Error 41.33032
Observations 10

ANOVA
df SS MS F Significance F
Regression 1 18934.9348 18934.9348 11.0848 0.01039

Residual 8 13665.5652 1708.1957

Total 9 32600.5000

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-52
 Simple Linear Regression Example:
Standard Error of Estimate in Minitab
DCOVA
The regression equation is

Price = 98.2 + 0.110 Square Feet

Predictor Coef SE Coef T P

Constant 98.25 58.03 1.69 0.129
Square Feet 0.10977 0.03297 3.33 0.010
S YX  41.33032
S = 41.3303 R-Sq = 58.1% R-Sq(adj) = 52.8%

Analysis of Variance

Source DF SS MS F P
Regression 1 18935 18935 11.08 0.010
Residual Error 8 13666 1708
Total 9 32600

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-53
 Comparing Standard Errors
DCOVA
SYX is a measure of the variation of observed
Y values from the regression line

Y Y

small SYX X large SYX X

The magnitude of SYX should always be judged relative to the

size of the Y values in the sample data
i.e., SYX = $41.33K is moderately small relative to house prices in
the $200K - $400K range
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-54
 Assumptions of Regression
L.I.N.E
DCOVA

 Linearity
 The relationship between X and Y is linear

 Independence of Errors
 Error values are statistically independent

 Normality of Error
 Error values are normally distributed for any given

value of X
 Equal Variance (also called homoscedasticity)
 The probability distribution of the errors has constant

variance

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-55
 Residual Analysis
DCOVA
ei  Yi  Ŷi
 The residual for observation i, ei, is the difference
between its observed and predicted value
 Check the assumptions of regression by examining the
residuals
 Examine for linearity assumption
 Evaluate independence assumption
 Evaluate normal distribution assumption
 Examine for constant variance for all levels of X
(homoscedasticity)

 Graphical Analysis of Residuals

 Can plot residuals vs. X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-56
 Residual Analysis for Linearity
DCOVA
Y Y

x x
residuals

residuals
x x

Not Linear
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall
 Linear
Chap 13-57
 Residual Analysis for
Independence
DCOVA

Not Independent
 Independent
residuals

residuals
X
residuals

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-58
 Checking for Normality
DCOVA
 Examine the Stem-and-Leaf Display of the
Residuals
 Examine the Boxplot of the Residuals
 Examine the Histogram of the Residuals
 Construct a Normal Probability Plot of the
Residuals

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-59
 Residual Analysis for Normality
DCOVA
When using a normal probability plot, normal
errors will approximately display in a straight line

Percent
100

0
-3 -2 -1 0 1 2 3
Residual

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-60
 Residual Analysis for
Equal Variance
DCOVA

Y Y

x x
residuals

residuals
x x

Non-constant variance  Constant variance

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-61
 Simple Linear Regression
Example: Excel Residual Output
DCOVA
RESIDUAL OUTPUT House Price Model Residual Plot
Predicted
House Price Residuals 80
1 251.92316 -6.923162 60
2 273.87671 38.12329
40
3 284.85348 -5.853484

Residuals
20
4 304.06284 3.937162
0
5 218.99284 -19.99284
0 1000 2000 3000
6 268.38832 -49.38832 -20

7 356.20251 48.79749 -40

8 367.17929 -43.17929 -60
9 254.6674 64.33264 Square Feet
10 284.85348 -29.85348
Does not appear to violate
any regression assumptions
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-62
 Simple Linear Regression
Example: Minitab Residual Output
DCOVA
Residual Plots for House Price (Y)
Normal Probability Plot Versus Fits
99
50
90

Residual
25
Percent

50
0

10 -25

-50
1
-100 -50 0 50 100 200 240 280 320 360
Residual Fitted Value

Histogram Versus Order

3
50
Frequency

Residual
2 25

0
1
-25

-50
0
-50 -25 0 25 50 75 1 2 3 4 5 6 7 8 9 10
Residual Observation Order

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-63
 Measuring Autocorrelation:
The Durbin-Watson Statistic
DCOVA

 Used when data are collected over time to

detect if autocorrelation is present
 Autocorrelation exists if residuals in one
time period are related to residuals in
another period

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-64
 Autocorrelation
DCOVA
 Autocorrelation is correlation of the errors
(residuals) over time
Time (t) Residual Plot

15
 Here, residuals show a 10
5

Residuals
cyclic pattern (not
0
random.) Cyclical
-5 0 2 4 6 8
patterns are a sign of -10
positive autocorrelation -15
T ime (t)

 Violates the regression assumption that

residuals are random and independent
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-65
 The Durbin-Watson Statistic
DCOVA
 The Durbin-Watson statistic is used to test for
autocorrelation
H0: residuals are not correlated
H1: positive autocorrelation is present

n  The possible range is 0 ≤ D ≤ 4

2
 (e  e
i 2
i i1 )
 D should be close to 2 if H0 is true
D n
2
i
e
i1
 D less than 2 may signal positive
autocorrelation, D greater than 2 may
signal negative autocorrelation

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-66
 Testing for Positive
Autocorrelation
DCOVA
H0: positive autocorrelation does not exist
H1: positive autocorrelation is present
 Calculate the Durbin-Watson test statistic = D
(The Durbin-Watson Statistic can be found using Excel or Minitab)

 Find the values dL and dU from the Durbin-Watson table

(for sample size n and number of independent variables k)

Decision rule: reject H0 if D < dL

Reject H0 Inconclusive Do not reject H0

0 dL dU 2
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-67
 Testing for Positive
Autocorrelation (continued)

DCOVA
 Suppose we have the following time series
data:
160

140

120

100
Sales

80 y = 30.65 + 4.7038x
2
60 R = 0.8976
40

20

0
0 5 10 15 20 25 30
Tim e

 Is there autocorrelation?
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-68
 Testing for Positive (continued)
Autocorrelation
DCOVA
160
 Example with n = 25: 140

120
Excel/PHStat output:
100

Sales
Durbin-Watson Calculations 80 y = 30.65 + 4.7038x
2
Sum of Squared 60 R = 0.8976
Difference of Residuals 3296.18 40

Sum of Squared 20

Residuals 3279.98 0
0 5 10 15 20 25 30
Durbin-Watson Tim e
Statistic 1.00494

n
2
 i i1
(e
i2
 e )
3296.18
D n
  1.00494
2 3279.98
 eii1
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-69
 Testing for Positive
Autocorrelation (continued)
DCOVA
 Here, n = 25 and there is k = 1 one independent variable

 Using the Durbin-Watson table, dL = 1.29 and dU = 1.45

 D = 1.00494 < dL = 1.29, so reject H0 and conclude that

significant positive autocorrelation exists

Decision: reject H0 since

D = 1.00494 < dL

Reject H0 Inconclusive Do not reject H0

0 dL=1.29 dU=1.45 2
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-70
 Inferences About the Slope
DCOVA
 The standard error of the regression slope
coefficient (b1) is estimated by

S YX S YX
Sb1  
SSX  i
(X  X ) 2

where:
Sb1 = Estimate of the standard error of the slope

SSE = Standard error of the estimate

S YX 
n2
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-71
 Inferences About the Slope:
t Test
DCOVA
 t test for a population slope
 Is there a linear relationship between X and Y?
 Null and alternative hypotheses
 H0: β1 = 0 (no linear relationship)
 H1: β1 ≠ 0 (linear relationship does exist)
 Test statistic where:
b1  β 1 b1 = regression slope
t STAT  coefficient
Sb β1 = hypothesized slope
1
Sb1 = standard
d.f.  n  2 error of the slope

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-72
 Inferences About the Slope:
t Test Example
DCOVA

House Price Estimated Regression Equation:

Square Feet
in $1000s
(x)
(y)
house price  98.25  0.1098 (sq.ft.)
245 1400
312 1600
279 1700
308 1875 The slope of this model is 0.1098
199 1100
219 1550
Is there a relationship between the
405 2350 square footage of the house and its
324 2450 sales price?
319 1425
255 1700

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-73
 Inferences About the Slope:
t Test Example
H0: β1 = 0 DCOVA

From Excel output: H1: β1 ≠ 0

Coefficients Standard Error t Stat P-value
Intercept 98.24833 58.03348 1.69296 0.12892
Square Feet 0.10977 0.03297 3.32938 0.01039

From Minitab output: b1 Sb1

Predictor Coef SE Coef T P
Constant 98.25 58.03 1.69 0.129
Square Feet 0.10977 0.03297 3.33 0.010

b1  β1 0.10977  0
t STAT    3.32938
b1 Sb1 Sb 0.03297
1

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-74
 Inferences About the Slope:
t Test Example
DCOVA
H0: β1 = 0
Test Statistic: tSTAT = 3.329 H1: β1 ≠ 0

d.f. = 10- 2 = 8

a/2=.025 a/2=.025
Decision: Reject H0

There is sufficient evidence

Reject H0
-tα/2
Do not reject H0
tα/2
Reject H0 that square footage affects
0
-2.3060 2.3060 3.329 house price

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-75
 Inferences About the Slope:
t Test Example
H0: β1 = 0 DCOVA
From Excel output: H1: β1 ≠ 0
Coefficients Standard Error t Stat P-value
Intercept 98.24833 58.03348 1.69296 0.12892
Square Feet 0.10977 0.03297 3.32938 0.01039

From Minitab output:

Predictor Coef SE Coef T P p-value
Constant 98.25 58.03 1.69 0.129
Square Feet 0.10977 0.03297 3.33 0.010

Decision: Reject H0, since p-value < α

There is sufficient evidence that

square footage affects house price.
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-76
 F Test for Significance
DCOVA
 F Test statistic: F MSR
STAT 
MSE

where SSR
MSR 
k
SSE
MSE 
n  k 1
where FSTAT follows an F distribution with k numerator and (n – k - 1)
denominator degrees of freedom

(k = the number of independent variables in the regression model)

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-77
 F-Test for Significance
Excel Output
DCOVA

Regression Statistics
Multiple R 0.76211
MSR 18934.9348
R Square 0.58082 FSTAT    11.0848
Adjusted R Square 0.52842 MSE 1708.1957
Standard Error 41.33032
Observations 10 With 1 and 8 degrees p-value for
of freedom the F-Test
ANOVA
df SS MS F Significance F
Regression 1 18934.9348 18934.9348 11.0848 0.01039
Residual 8 13665.5652 1708.1957
Total 9 32600.5000

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-78
 F-Test for Significance
Minitab Output
DCOVA

Analysis of Variance

Source DF SS MS F P p-value for

Regression 1 18935 18935 11.08 0.010 the F-Test
Residual Error 8 13666 1708
Total 9 32600

With 1 and 8 degrees MSR 18934.9348

of freedom
FSTAT    11.0848
MSE 1708.1957

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-79
 F Test for Significance
(continued)

DCOVA
H0: β1 = 0 Test Statistic:
H1: β1 ≠ 0 MSR
FSTAT   11.08
a = .05 MSE
df1= 1 df2 = 8
Decision:
Critical Reject H0 at a = 0.05
Value:
Fa = 5.32
a = .05 Conclusion:
There is sufficient evidence that
0 F house size affects selling price
Do not Reject H0
reject H0
F.05 = 5.32
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-80
 Confidence Interval Estimate
for the Slope
DCOVA
Confidence Interval Estimate of the Slope:
b1  t α / 2 S b d.f. = n - 2
1

Excel Printout for House Prices:

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580

At 95% level of confidence, the confidence interval for

the slope is (0.0337, 0.1858)

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-81
 Confidence Interval Estimate
for the Slope (continued)
DCOVA
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
Intercept 98.24833 58.03348 1.69296 0.12892 -35.57720 232.07386
Square Feet 0.10977 0.03297 3.32938 0.01039 0.03374 0.18580

Since the units of the house price variable is

$1000s, we are 95% confident that the average
impact on sales price is between $33.74 and
$185.80 per square foot of house size

This 95% confidence interval does not include 0.

Conclusion: There is a significant relationship between
house price and square feet at the .05 level of significance

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-82
 Confidence Interval Estimate
for the Slope from Minitab (continued)
DCOVA
Minitab does not automatically calculate a confidence
interval for the slope but provides the quantities necessary
to use the confidence interval formula.

Predictor Coef SE Coef T P

Constant 98.25 58.03 1.69 0.129
Square Feet 0.10977 0.03297 3.33 0.010

b1  t α / 2 S b
1

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-83
 t Test for a Correlation Coefficient
DCOVA
 Hypotheses
H0: ρ = 0 (no correlation between X and Y)
H1: ρ ≠ 0 (correlation exists)

 Test statistic
r -ρ
t STAT  (with n – 2 degrees of freedom)
2
1 r where

n2 r   r 2 if b1  0

r   r 2 if b1  0
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-84
 t-test For A Correlation Coefficient
(continued)

DCOVA
Is there evidence of a linear relationship
between square feet and house price at the
.05 level of significance?

H0: ρ = 0 (No correlation)

H1: ρ ≠ 0 (correlation exists)
a =.05 , df = 10 - 2 = 8

r ρ .762  0
t STAT    3.329
1 r2 1  .762 2
n2 10  2

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-85
 t-test For A Correlation Coefficient
(continued)

DCOVA

r ρ .762  0 Decision:
t STAT    3.329
Reject H0
1 r2 1  .762 2
n2 10  2 Conclusion:
There is
d.f. = 10-2 = 8
evidence of a
linear association
a/2=.025 a/2=.025
at the 5% level of
significance
Reject H0 Do not reject H0 Reject H0
-tα/2 tα/2
0
-2.3060 2.3060
3.329
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-86
 Estimating Mean Values and
Predicting Individual Values
DCOVA
Goal: Form intervals around Y to express
uncertainty about the value of Y for a given Xi
Confidence
Interval for Y 
the mean of Y
Y, given Xi


Y = b0+b1Xi

Prediction Interval
for an individual Y,
given Xi
Xi X
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-87
 Confidence Interval for
the Average Y, Given X
DCOVA
Confidence interval estimate for the
mean value of Y given a particular Xi

Confidence interval for μ Y|X  X :

i

Yˆ  t α / 2 S YX hi

Size of interval varies according

to distance away from mean, X

1 (Xi  X)2 1 (Xi  X)2

hi    
n SSX n  (Xi  X)2
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-88
 Prediction Interval for
an Individual Y, Given X
DCOVA
Confidence interval estimate for an
Individual value of Y given a particular Xi

Confidence interval for YX  X :

i

Yˆ  t α / 2 S YX 1  hi

This extra term adds to the interval width to reflect

the added uncertainty for an individual case

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-89
 Estimation of Mean Values:
Example DCOVA
Confidence Interval Estimate for μY|X=X
i

Find the 95% confidence interval for the mean price

of 2,000 square-foot houses

Predicted Price Yi = 317.78 ($1,000s)

1 (X i  X ) 2
Ŷ  t 0.025SYX   317.78  37.12
n  (X i  X) 2

The confidence interval endpoints are 280.66 and 354.90,

or from $280,660 to $354,900
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-90
 Estimation of Individual Values:
Example DCOVA
Prediction Interval Estimate for YX=X
i

Find the 95% prediction interval for an individual

house with 2,000 square feet

Predicted Price Yi = 317.85 ($1,000s)

1 (X i  X ) 2
Ŷ  t 0.025SYX 1   317.78  102.28
n  (X i  X ) 2

The prediction interval endpoints are 215.50 and 420.07,

or from $215,500 to $420,070
Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-91
 Finding Confidence and
Prediction Intervals in Excel
DCOVA

 From Excel, use

PHStat | regression | simple linear regression …

 Check the
“confidence and prediction interval for X=”
box and enter the X-value and confidence level
desired

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-92
 Finding Confidence and
Prediction Intervals in Excel
(continued)
DCOVA

Input values


Y

Confidence Interval Estimate for μY|X=Xi

Prediction Interval Estimate for YX=Xi

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-93
 Finding Confidence and
Prediction Intervals in Minitab
DCOVA
Confidence Interval Estimate for μY|X=Xi

Predicted Values for New Observations

New
Obs Fit SE Fit 95% CI 95% PI
1 317.8 16.1 (280.7, 354.9) (215.5, 420.1)

 Values of Predictors for New Observations

Y
New Square
Obs Feet
1 2000

Prediction Interval Estimate for YX=Xi

Input values

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-94
 Pitfalls of Regression Analysis

 Lacking an awareness of the assumptions

underlying least-squares regression
 Not knowing how to evaluate the assumptions
 Not knowing the alternatives to least-squares
regression if a particular assumption is violated
 Using a regression model without knowledge of
the subject matter
 Extrapolating outside the relevant range

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-95
 Strategies for Avoiding
the Pitfalls of Regression
 Start with a scatter plot of X vs. Y to observe
possible relationship
 Perform residual analysis to check the
assumptions
 Plot the residuals vs. X to check for violations of
assumptions such as homoscedasticity
 Use a histogram, stem-and-leaf display, boxplot,
or normal probability plot of the residuals to
uncover possible non-normality

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-96
 Strategies for Avoiding
the Pitfalls of Regression
(continued)

 If there is violation of any assumption, use

alternative methods or models
 If there is no evidence of assumption violation,
then test for the significance of the regression
coefficients and construct confidence intervals
and prediction intervals
 Avoid making predictions or forecasts outside
the relevant range

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-97
 Chapter Summary

 Introduced types of regression models

 Reviewed assumptions of regression and
correlation
 Discussed determining the simple linear
regression equation
 Described measures of variation
 Discussed residual analysis
 Addressed measuring autocorrelation

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-98
 Chapter Summary
(continued)

 Described inference about the slope

 Discussed correlation -- measuring the strength
of the association
 Addressed estimation of mean values and
prediction of individual values
 Discussed possible pitfalls in regression and
recommended strategies to avoid them

Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall Chap 13-99