L1 The SLR Model
L1 The SLR Model
Terminology
yi = β0 + β1 xi + ui
yi = β0 + β1 x1i + β2 x2i + ui
≡ y = Xβ + u
where y and u are (n × 1), X is (n × K ) and β is (K × 1).
The population parameters β describe how x are related to y .
(In the simple linear regression case, (with one x variable) if u were
unchanged, then the slope parameter β1 captures how y changes
with a unit change in x.)
These population parameters are generally unknown, and must be
estimated from a random sample of observations.
u captures all factors other than those captured by xs that explain
y . u is referred to as the error term or disturbance term, and is
unobserved.
y is thus composed of a systematic part (x, β) + an unsystematic
(unobserved) part (u).
The Simple Linear Regression Model
To begin with, let’s start with the simple linear regression model:
yi = β0 + β1 xi + ui
β0 is termed the constant, or intercept, and β1 is the slope
parameter. As noted earlier, these are unknown and must be
estimated using a random sample of observations or data on y and
x of size n, with i denoting the observation.
Assumptions in the SLR model
ûi2
P
OLS involves minimizing the sum of squared residuals (SSR)
n
X n
X
Minβ̂0 ,β̂1 S = ûi2 = [yi − β̂0 − β̂1 xi ]2
i i
n n n
∂S X X X X
= −2[yi −β̂0 −β̂1 xi ]xi = 0 ⇒ xi yi = β̂0 xi +β̂1 xi2 (2)
∂β1
i i i