Introduction to Statistics

and Econometrics

Professor Yongmiao Hong

Cornell University
May 23, 2019
 CONTENTS

1.1 General methodology of modern

economic research
1.2 Roles of Econometrics

1.3 Illustrative Examples

1.4 Roles of Probability and Statistics

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 2
General methodology of modern economic research Step 1: Data collections and summary of empirical stylized facts

Step 1: Data collections and summary of empirical stylized facts

economic Empirical
Data
theories validation Applications
collections
/models /inference

Data collections:
 surveys
 field studies
 experimental
economics
 Big data
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 3
General methodology of modern economic research Step 1: Data collections and summary of empirical stylized facts

Step 1: Data collections and summary of empirical stylized facts

Example 2: Phillips Curve in macroeconomics:

A negative correlation between the inflation rate and the
unemployment rate in an aggregate economy;

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 5
General methodology of modern economic research Step 1: Data collections and summary of empirical stylized facts

Step 1: Data collections and summary of empirical stylized facts

Example 3: volatility clustering in finance:

A high volatility today tends to be followed by another high
volatility tomorrow, a low volatility today tends to be
followed by another low volatility tomorrow, and both
alternate over time.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 6
General methodology of modern economic research Step 1: Data collections and summary of empirical stylized facts

Step 1: Data collections and summary of empirical stylized facts

a starting point
the empirical serve as for economic
stylized facts
research

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 7
General methodology of modern economic research Step 2: Development of economic theories/models

Step 2: Development of economic theories/models

economic Empirical
Data
theories validation Applications
collections
/models /inference

● With the empirical stylized facts in mind,

economists then develop an economic theory or
model.
● This usually calls for specifying a mathematical
model of economic theory.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 8
General methodology of modern economic research Step 2: Development of economic theories/models

Step 2: Development of economic theories/models

• An example is the Euler equation for rational

expectations in macroeconomics.
• The objective of economic modeling is not merely
to explain the stylized facts, but also to
understand the economic mechanism.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 9
General methodology of modern economic research Step 3: Empirical validation/inference of economic models

Step 3: Empirical validation/inference of economic models

economic Empirical
Data
theories validation Applications
collections
/models /inference

• A key is to transform an economic model into a

testable empirical econometric model.
• One often has to assume some functional form,
up to some unknown model parameters, or to
choose suitable instrumental variables to form a
set of moment conditions.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 10
General methodology of modern economic research Step 3: Empirical validation/inference of economic models

Step 3: Empirical validation/inference of economic models

• One needs to estimate unknown model

parameters and make inferences based on
observed data.
• Check whether the econometric model is
adequate. An adequate model should be at least
consistent with the empirical stylized facts.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 11
General methodology of modern economic research Step 4: Applications

Step 4: Applications
economic Empirical
Data
theories validation Applications
collections
/models /inference
After an econometric model passes the empirical
evaluation, it can then be used to:
Explain important empirical stylized facts

Test economic theory and/or hypotheses

Forecast future evolution of the economy

Policy evaluation and other applications

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 12
 CONTENTS

1.1 General methodology of modern

economic research
1.2 Roles of Econometrics

1.3 Illustrative Examples

1.4 Roles of Probability and Statistics

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 13
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

Modern econometrics is essentially built upon the

following fundamental axioms:

Any economy can be viewed as a stochastic process

governed by some probability law.

Economic phenomenon, often summarized in form of

data, can be reviewed as a realization of this stochastic
data generating process (DGP).

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 14
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

Remarks:

● Modern economy is full of uncertainty, e.g., market

(demand, supply and price) uncertainty, policy
uncertainty

● The probability law of this stochastic economic system

characterizes the evolution of the economy, and can
be viewed as “law of economic motions.”

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 15
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

● The goal of econometrics:

To infer the probability law of the stochastic economic

system based on observed data, and then use the
inferred probability law for economic applications.

For example, economic theory usually takes a form of

imposing certain restrictions on the probability law.
Thus, one can test economic theory or economic
hypotheses by checking the validity of these
restrictions.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 16
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

● Tools and methods of probability and statistics

will provide operating principles for
econometrics. For examples,

model parameter hypothesis model

specification estimation testing validation

● Econometrics is not a simple application of a

general theory of mathematical statistics to
economic data.
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 17
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

“Econometrics is by no means the same as

economic statistics. Nor is it identical with what
we call general economic theory, although a
considerable portion of this theory has a
definitely quantitative character. Nor should
econometrics be taken as synonymous with the
application of mathematics to economics.
Experience has shown that each of these three
viewpoints, that of statistics, economic theory,
and mathematics, is a necessary, but not by itself Ragnar Frisch
a sufficient, condition for a real understanding of (1933)
the quantitative relations in modern economic
life. It is the unification of all three that is
powerful. And it is this unification that
constitutes econometrics.”
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 18
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

▫ Predict the future evolution of the economy

▫ Recommend business strategies and evaluate

economic policies.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 20
Roles of Econometrics Fundamental Axioms of Econometrics

Fundamental Axioms of Econometrics

● To appreciate the roles of modern

econometrics in economic analysis, we now
discuss a number of illustrative econometric
examples in various fields of economics and
finance.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 21
 CONTENTS

1.1 General methodology of modern

economic research
1.2 Roles of Econometrics

1.3 Illustrative Examples

1.4 Roles of Probability and Statistics

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 22
Illustrative Examples Example 1: Keynes Model, Multiplier and Policy Recommendation

Example 1: Keynesian Model, Multiplier and Policy Recommendation

The Simple Keynesian Model

where
𝑌𝑡 is aggregate income,
𝐶𝑡 is private consumption,
𝐼𝑡 is private investment,
𝐺𝑡 is government spending,
𝜀𝑡 is consumption shock.
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 23
Illustrative Examples Example 1: Keynes Model, Multiplier and Policy Recommendation

Example 1: Keynesian Model, Multiplier and Policy Recommendation

The parameters 𝛼 and 𝛽 can have appealing

economic interpretations:
• 𝛼 is survival level consumption,
• 𝛽 is the marginal propensity to consume (MPC).

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 24
Illustrative Examples Example 1: Keynes Model, Multiplier and Policy Recommendation

Example 1: Keynesian Model, Multiplier and Policy Recommendation

Multiplier of income with respect to government

spending:

which depends on the marginal propensity to

consume 𝛽.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 25
Illustrative Examples Example 1: Keynes Model, Multiplier and Policy Recommendation

Example 1: Keynesian Model, Multiplier and Policy Recommendation

To assess the effect of fiscal policies on the

economy, it is important to know the magnitude
of 𝛽.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 26
Illustrative Examples Example 2: Rational Expectations and Dynamic Asset Pricing Models

Example 2: Rational Expectations and Dynamic Asset Pricing Models

Suppose a representative agent has a constant

relative risk aversion utility

where
𝛽>0 is the agent's time discount factor,
𝛾≥0 is the risk aversion parameter,
𝜇(∙) is the agent's utility function in each time period,
𝐶𝑡 is consumption during period 𝑡.
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 27
Illustrative Examples Example 2: Rational Expectations and Dynamic Asset Pricing Models

Example 2: Rational Expectations and Dynamic Asset Pricing Models

The agent's optimization problem is to choose a

sequence of consumptions 𝐶𝑡 over time to

subject to the intertemporal budget constraint

where
𝑞𝑡 is the quantity of the asset purchased at time 𝑡,
𝑊𝑡 is the agent’s period 𝑡 income.
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 28
Illustrative Examples Example 2: Rational Expectations and Dynamic Asset Pricing Models

Example 2: Rational Expectations and Dynamic Asset Pricing Models

Define the marginal rate of intertemporal

substitution

where model parameter vector 𝜃 = 𝛽, 𝛾 ′ .

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 29
Illustrative Examples Example 2: Rational Expectations and Dynamic Asset Pricing Models

Example 2: Rational Expectations and Dynamic Asset Pricing Models

First order condition (FOC) of the agent's

optimization problem:

where
𝑅𝑡+1 is the stochastic gross return on the risky asset,
𝐼𝑡 is information set available at time 𝑡.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 30
Illustrative Examples Example 2: Rational Expectations and Dynamic Asset Pricing Models

Example 2: Rational Expectations and Dynamic Asset Pricing Models

● This FOC is usually called the Euler equation of

the economic system.

● Questions:
● • How to estimate this model?
● • How to test validity of a rational expectations model?

● Need to use generalized method of moments (GMM)

(see Hansen 1982).

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 31
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

Production function:

where
𝑌𝑖 = output of firm 𝑖,
𝐿𝑖 = labor of firm 𝑖,
𝐾𝑖 = capital of firm 𝑖,
𝜀𝑖 = is a shock (e.g., uncertain weather condition if
𝑌𝑖 is an agricultural product).

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 32
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

Constant return to scale (CRS):

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 33
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

CRS is a necessary condition for the existence of a

long-run equilibrium of a competitive market
economy.
• If CRS does not hold, and the technology displays the
increasing return to scale (IRS), then the industry will
lead to natural monopoly.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 34
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

A conventional approach to testing CRS:

• Assume the production function is a Cobb-Douglas function:

• Then CRS becomes a mathematical restriction on parameters (𝛼, 𝛽) :

• If 𝛼 + 𝛽 > 1, the production technology displays IRS.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 35
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

● In statistics, a popular procedure to test one-

dimensional parameter restriction is Student's t-
test.
● Unfortunately, this test is not suitable for many
cross-sectional economic data, which usually
display conditional heteroskedasticity.
● One needs to use a robust, heteroskedasticity-
consistent test procedure, originally proposed in
White (1980).
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 36
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

It should be emphasized that CRS is equivalent to

the statistical hypothesis

under the assumption that the production

technology is a Cobb-Douglas function. This
additional condition on the production function is
not part of CRS and is called an auxiliary
assumption.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 37
Illustrative Examples Example 3: Production Function and Hypothesis on Constant Return to Scale

Example 3: Production Function and Hypothesis on Constant Return to Scale

If the auxiliary assumption is incorrect, the

statistical hypothesis

will not be equivalent to CRS. Correct model

specification is essential for a valid conclusion and
interpretation for econometric inference.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 38
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

Extended Cobb-Dauglas production function (after

taking a logarithmic operation)

where 𝑖 is the index for firm 𝑖 ∈ 1, … , 𝑁 and 𝑡 is the index for year
𝑡 ∈ 1, … , 𝑇 ,
• Bonus𝑖𝑡 is proportion of bonus out of total wage bill,
• Contract𝑖𝑡 is proportion of workers who have signed a fixed-term
contract.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 39
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

● This is an example of the so-called panel data model

(see, e.g., Hsiao 2003).

● Bonuses and fixed-term contracts were two innovative

incentive reforms in Chinese state-owned enterprises
in 1980s, compared to the fixed wage and life-time
employment systems in the pre-reform era.

● To examine effects of these incentive reforms, we

consider the null statistical hypothesis

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 40
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

● Conventional F-tests in classical linear regression

would serve our purpose, if we can assume conditional
homoskedasticity.

● Unfortunately, this cannot be used because there may

exist the other way of causation from Y𝑖𝑡 to Bonus𝑖𝑡 ;
namely a productive firm may pay its workers higher
bonuses regardless of their efforts:

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 41
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

● Causality from bonus to productivity will cause

correlation between bonuses and error term 𝑢𝑖𝑡 ,
rendering the OLS estimator inconsistent and
invalidating the conventional t-tests or F-tests.

● Fortunately, econometricians have developed an

important estimation procedure called Instrumental
Variables estimation, which can effectively filter out
the impact of the causation from output to bonus and
obtain a consistent estimator for the bonus parameter.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 42
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

In evaluating the effect of economic reforms, we have

turned an economic hypothesis into a statistical
hypothesis

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 43
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

When the hypothesis

is not rejected, we should not conclude that reforms have

no effect. This is because the extended production
function model, where reforms are specified additively, is
only one of many ways to check effect of reforms. For
example, one could also specify a model such that the
reforms affect marginal productivities of labor and capital.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 44
Illustrative Examples Example 4: Effect of Economic Reforms on Transitional Economy

Example 4: Effect of Economic Reforms on Transitional Economy

Thus, when the hypothesis

is not rejected, we can only say that we do not find

evidence against the economic hypothesis that the reforms
have no effect.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 45
Illustrative Examples Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Weak form of efficient market hypothesis (EMH):

It is impossible to predict future stock returns using
the history of past stock returns:

where
𝑌𝑡 = asset return at time 𝑡,
𝐼𝑡−1 = {𝑌𝑡−1 , … , 𝑌1 } is the information set at time 𝑡 − 1.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 46
Illustrative Examples Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

● When EMH holds, past information of stock

returns has no predictive power for future stock
returns.
● An important implication of EMH is that mutual
fund managers will have no informational
advantage over layman investors.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 47
Illustrative Examples Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Question: How to test EMH?

• One simple way to test EMH is to consider
autoregression:
𝑝

𝑌𝑡 = 𝛼0 + ෍ 𝛼𝑗 𝑌𝑡−𝑗 + 𝜀𝑡
𝑗=1

where
p is a pre-selected number of lags,
𝜀𝑡 is a random disturbance.
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 48
Illustrative Examples Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Question: How to test EMH?

● EMH implies

Thus, any nonzero coefficient 𝛼𝑗 , 1 ≤ 𝑗 ≤ 𝑝, is evidence

against EMH.

● One can test whether the 𝛼𝑗 are jointly zero. The

classical F-test can be used to test 𝐇0 when
𝑣𝑎𝑟(𝜀𝑡 𝐼𝑡−1 = 𝜎 2 , i.e., there exists conditional
homoscedasticity.
Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 49
Illustrative Examples Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

● However, EMH may coexist with volatility clustering ( i.e.,

𝑣𝑎𝑟(𝜀𝑡 𝐼𝑡−1 may be time-varying), which is one of the
most important empirical stylized facts of financial
markets. This implies that the standard F-test statistic
cannot be used, even asymptotically. One has to use
procedures that are robust to conditional
heteroskedasticity.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 50
Illustrative Examples Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

Example 5: Efficient Market Hypothesis (EMH) and Predictability of Financial Returns

● When one rejects the null hypothesis 𝐇0 that the 𝛼𝑗 are

jointly zero, we have evidence against EMH. However,
when one fails to reject 𝐇0 , one can only conclude that
we do not find evidence against EMH. The reason is,
again, that the linear AR(p) model is one of many
possibilities to check EMH.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 51
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● Since 1970s, oil crisis, the floating foreign exchanges

system, and the high interest rate policy in the U.S. have
stimulated a lot of uncertainty in the world economy.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 52
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● Volatility is a key instrument for measuring uncertainty

and risk in finance. This concept is important to
investigate information flows and volatility spillover,
financial contagions between financial markets, options
pricing, and calculation of Value at Risk.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 53
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● Volatility can be measured by the conditional

variance of asset return 𝑌𝑡 given the information
𝐼𝑡−1 :

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 54
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● A popular volatility model is the AutoRegressive

Conditional Heteroskedasticity (ARCH) model,
originally proposed by Engle (1982).
Engle's (1982) ARCH(q) model

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 55
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● ARCH(q) can explain a well-known stylized fact in

financial markets-volatility clustering. It can also
explain the non-Gaussian heavy tail of asset
returns.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 56
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● Question: How to estimate a volatility model?

• Because the conditional distribution of 𝑌𝑡 is unknown, the
popular maximum likelihood estimation (MLE) method cannot be
used.

• Nevertheless, one can assume that standardized innovation {𝑧𝑡 }

is i.i.d.N(0,1), and obtain a conditional distribution of 𝑌𝑡 given
𝐼𝑡−1 Then one can estimate model parameters using MLE.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 57
Illustrative Examples Example 6: Volatility Clustering and ARCH Models

Example 6: Volatility Clustering and ARCH Models

● Question: How to estimate a volatility model?

• Since {𝑧𝑡 } is not necessarily i.i.d.N(0,1), the above estimation
procedure is called Quasi-MLE or QMLE (White 1982).

• QMLE is consistent for true model parameters, but its

asymptotic variance is larger than that of the MLE (i.e., when the
true distribution of {𝑧𝑡 } is known)

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 58
 CONTENTS

1.1 General methodology of modern

economic research
1.2 Roles of Econometrics

1.3 Illustrative Examples

1.4 Roles of Probability and Statistics

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 59
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

Econometrics is an integration of statistical modeling

and inferences of economic observational data with
economic theory.

The objective of econometrics is to infer laws of

economic motions of a stochastic economy

Theory, methods and tools of econometrics are

mathematical statistics in combination with
economic theory.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 60
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

● Probability theory provides operating rules and

understanding of mathematical statistics.

● In fact, as perhaps the best mathematical tool to describe

uncertainty, probability theory has been very useful
analytic tools for macroeconomics, microeconomics and
finance.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 61
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

● Probability and Statistics together provide a foundation

for econometrics. In particular, they provides the
concepts, tools and methods of mathematical statistics
which are needed to understand econometrics.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 62
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

Modern statistics usually

• assumes that a mathematical probability model
generates an observed data.

• assumes that the probability model often contains

some unknown parameters.

• based on the observed data, develop methods to

estimate unknown parameters and statistical
hypotheses.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 63
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

For such statistical analysis, one would need to know

a variety of important concepts and tools, such as:

• mean • maximum likelihood estimation

• variance • method of moment estimation
• quantile • t- and F-distributions
• conditional mean • convergence concepts
• conditional variance (e.g., almost sure convergence)?
• conditional quantile • law of large numbers
• correlation • central limit theorems
• sample and data

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 64
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

As a distinctive feature from other probability /

statistics courses, this course will offer intuitions,
explanations and potential applications for tools
and methods of mathematical statistics from an
economic perspective.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 65
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

How to characterize income inequality by

cumulative probability distribution? Lorenz curve!
Why are mean and variance important in
economic analysis?

What is an economic interpretation for law of

large numbers?
What are economic implications of model
misspecication? Model risk!

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 66
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

There are many different approaches of data analysis. In

the era of Big Data, which contain structural and
unstructured data, an emerging field for Big data analysis is
data science, which employs different approaches (e.g.,
statistics, machine learning, etc.) to analyze data.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 67
Roles of Probability and Statistics Roles of Probability and Statistics

Roles of Probability and Statistics

Statistics remains as an important approach to

analyzing data including Big data.

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 68
 Textbook & Website

 Textbook

概率论与统计学 Probability and Statistics for Economists

中国统计出版社,2017 World Scientific Publishing Company (November 2, 2017)

 Website
https://probability.xmu.edu.cn

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 69
 Thank You !

Probability and Statistics for Economists Introduction to Statistics and Econometrics May 23, 2019 70