Introduction  to  Econometrics  (3rd  Updated  Edition)  
 
 
by  
 
 
James  H.  Stock  and  Mark  W.  Watson  
 
 
 
 
 
Solutions  to  End-­‐of-­‐Chapter  Exercises:  Chapter  5*  
 
 
(This version August 17, 2014)
 
 
 
 
 
 
 
 
 
 
 
*Limited  distribution:  For  Instructors  Only.    Answers  to  all  odd-­‐numbered  
questions  are  provided  to  students  on  the  textbook  website.      If  you  find  errors  in  
the  solutions,  please  pass  them  along  to  us  at  [email protected].    

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 1
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5.1 (a) The 95% confidence interval for β1 is {−5.82 ± 1.96 × 2.21}, that is

−10.152 ≤ β1 ≤ −1.4884.

(b) Calculate the t-statistic:

βˆ 1 − 0 −5.82
t act = = = −2.6335.
SE( βˆ 1) 2.21

The p-value for the test H 0 : β1 = 0 vs. H1 : β1 ≠ 0 is

p-value = 2Φ(−|t act |) = 2Φ (−2.6335) = 2 × 0.0042 = 0.0084.

The p-value is less than 0.01, so we can reject the null hypothesis at the 5%
significance level, and also at the 1% significance level.

(c) The t-statistic is

βˆ 1 − (−5.6) 0.22
t act = = = 0.10
SE ( βˆ 1) 2.21

The p-value for the test H 0 : β1 = −5.6 vs. H1 : β1 ≠ −5.6 is

p-value = 2Φ (−|t act |) = 2Φ (−0.10) = 0.92

The p-value is larger than 0.10, so we cannot reject the null hypothesis at the
10%, 5% or 1% significance level. Because β1 = −5.6 is not rejected at the 5%

level, this value is contained in the 95% confidence interval.

(d) The 99% confidence interval for b0 is {520.4 ± 2.58 × 20.4}, that is,

467.7 ≤ β0 ≤ 573.0.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 2
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5.2. (a) The estimated gender gap equals $2.12/hour.

(b) The hypothesis testing for the gender gap is H 0 : β1 = 0 vs. H1 : β1 ≠ 0. With a t-

βˆ 1 − 0 2.12
statistic t act = = = 5.89, the p-value for the test is
SE ( βˆ 1) 0.36

p-value = 2Φ(−|t act |) = 2Φ (−5.89) = 2 × 0.0000 = 0.000 (to four decimal

places)The p-value is less than 0.01, so we can reject the null hypothesis that there
is no gender gap at a 1% significance level.

(c) The 95% confidence interval for the gender gap β1 is {2.12 ± 1.96 × 0.36}, that

is, 1.41 ≤ β1 ≤ 2.83.

(d) The sample average wage of women is βˆ0 = $12.52/hour. The sample average

wage of men is βˆ 0 + βˆ 1 = $12.52 + $2.12 = $14.64/hour.

(e) The binary variable regression model relating wages to gender can be written as
either Wage = β0 + β1Male + ui , or Wage = γ 0 + γ 1Female + vi . In the first

regression equation, Male equals 1 for men and 0 for women; β 0 is the

population mean of wages for women and β0 + β1 is the population mean of

wages for men. In the second regression equation, Female equals 1 for women
and 0 for men; γ 0 is the population mean of wages for men and γ 0 + γ 1 is the
population mean of wages for women. We have the following relationship for the
coefficients in the two regression equations:

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 3
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5.2 (continued)

γ 0 = β 0 + β1 ,
γ 0 + γ 1 = β0 .

Given the coefficient estimates β̂ 0 and βˆ 1 , we have

γˆ 0 = βˆ 0 + βˆ 1 = 14.64,
γˆ1 = βˆ 0 − γˆ 0 = −βˆ 1 = −2.12.

Due to the relationship among coefficient estimates, for each individual

observation, the OLS residual is the same under the two regression equations:

uˆ i = vˆi. Thus the sum of squared residuals, SSR = ∑ i =1 uˆ i , is the same under the
2 n

two regressions. This implies that both SER = ( SSR

n −1 )
1
2
and R 2 = 1 − TSS
SSR
are

unchanged.

In summary, in regressing Wages on Female, we will get

! = 14.64 − 2.12Female,
Wages R2 = 0.06, SER = 4.2.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 4
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5.3. The 99% confidence interval is 1.5 × {3.94 ± 2.58 × 0.31) or

4.71 lbs ≤ WeightGain ≤ 7.11 lbs.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 5
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5.4. (a) −7.29 + 1.93 × 16 = $23.59 per hour

(b) The wage is expected to increase by 1.93×2 = $3.86 per hour.

(c) The increase in wages for college education is β1 × 4. Thus, the counselor’s
assertion is that β1 = 10/4 = 2.50. The t-statistic for this null hypothesis is

t = 1.93−2.50
0.08
= −7.13, which has a p-value of 0.00. Thus, the counselor’s assertion

can be rejected at the 1% significance level. A 95% confidence for β1 × 4 is 4 ×

(1.93 ± 1.96 × 0.08) or $7.09 ≤ Gain ≤ $8.35.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 6
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5. 5 (a) The estimated gain from being in a small class is 13.9 points. This is equal to
approximately 1/5 of the standard deviation in test scores, a moderate increase.

(b) The t-statistic is t act = 13.9

2.5 = 5.56,
which has a p-value of 0.00. Thus the null
hypothesis is rejected at the 5% (and 1%) level.

(c) 13.9 ± 2.58 × 2.5 = 13.9 ± 6.45.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 7
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5.6. (a) The question asks whether the variability in test scores in large classes is the
same as the variability in small classes. It is hard to say. On the one hand, teachers
in small classes might able so spend more time bringing all of the students along,
reducing the poor performance of particularly unprepared students. On the other
hand, most of the variability in test scores might be beyond the control of the
teacher.

(b) The formula in 5.3 is valid for heteroskesdasticity or homoskedasticity; thus

inferences are valid in either case.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 8
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5.7. (a) The t-statistic is 3.2

1.5 = 2.13 with a p-value of 0.03; since the p-value is less than
0.05, the null hypothesis is rejected at the 5% level.

(b) 3.2 ± 1.96 × 1.5 = 3.2 ± 2.94

(c) Yes. If Y and X are independent, then β1 = 0; but this null hypothesis was rejected
at the 5% level in part (a).

(d) β1 would be rejected at the 5% level in 5% of the samples; 95% of the

confidence intervals would contain the value β1 = 0.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 9
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5.8. (a) 43.2 ± 2.05 × 10.2 or 43.2 ± 20.91, where 2.05 is the 5% two-sided critical value
from the t28 distribution.

(b) The t-statistic is t act = 61.5−55

7.4 = 0.88, which is less (in absolute value) than the
critical value of 20.5. Thus, the null hypothesis is not rejected at the 5% level.

(c) The one sided 5% critical value is 1.70; tact is less than this critical value, so that
the null hypothesis is not rejected at the 5% level.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 10
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1
(Y1 + Y2 +!+ Yn )
5.9. (a) β = n
so that it is linear function of Y1, Y2, …, Yn.
X

(b) E(Yi|X1, …, Xn) = β1Xi, thus

1 1
E( β |X 1 ,…, X n ) = E (Y + Y +!+ Yn )|X 1 ,…, X n )
X n 1 2
1 1
= β ( X +!+ X n ) = β1
X n 1 1

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 11
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5.10. Let n0 denote the number of observation with X = 0 and n1 denote the number of

∑ ∑
n n
observations with X = 1; note that i =1
X i = n1; X = n1| n; 1
n1 i =1
X iYi = Y1;

∑ ( )
( X i − X ) 2 =∑ i =1 X i2 − nX 2 = n1 − nn1 = n1 1 − nn1 = ; n1Y1 + n0Y0 = ∑ i =1Yi , so
n n 2
n1n0 n
i =1 n

that Y = nn1 Y1 + nn0 Y0

From the least squares formula

∑ i=1
n
( X i − X )(Yi − Y ) ∑ i=1
n
X i (Yi − Y ) ∑ i=1
n
X iYi − Yn1
β̂1 = = n =
∑ i=1 ( X i − X )
n 2
∑ i=1 ( X i − X ) 2
n1n0 |n
n n⎛ n n ⎞
= (Y1 − Y ) = ⎜ Y − 1 Y1 − 0 Y0 ⎟ = Y1 − Y0 ,
n0 n0 ⎝ n n ⎠

⎛n n ⎞ n n +n0
and βˆ0 = Y − βˆ1 X = ⎜ 0 Y0 + 1 Y1 ⎟ − (Y1 − Y0 ) 1 = 1 Y0 = Y0
⎝n n ⎠ n n

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 12
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5.11. Using the results from 5.10, βˆ0 = Ym and βˆ1 = Yw − Ym . From Chapter 3,

+ nww . Plugging in the numbers βˆ0 = 523.1 and

Sm sm2 s2
SE (Ym ) = nm
and SE (Yw − Ym ) = nm

SE (βˆ0 ) = 6.22; βˆ1 = −38.0 and SE (βˆ1 ) = 7.65.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 13
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5.12. Equation (4.22) gives

var (H i ui ) µX
σ β2ˆ = , where H i = 1 − Xi.
n ⎡⎣ E ( H i2 )⎤⎦ E ( X i2 )
0
2

Using the facts that E (ui | X i ) = 0 and var (ui | X i ) = σ u2 (homoskedasticity), we have

⎛ ⎞
⎜ µx ⎟ µx
E ( H i ui ) = E u − ⎜
X u = E (ui ) −
⎟
E [ X i E (ui | X i )]
E(X ) E ( X i2 )
⎜ i 2 i i⎟
⎜⎜ ⎟⎟
⎝ i ⎠

=0−
µx × 0 = 0,
E ( X i2 )

and

⎧⎛ ⎞ 2 ⎫⎪
⎪⎜
⎪⎪ ⎜ µX ⎟
⎟ ⎪⎪
E [( H i ui ) ] = E u −
2
⎨⎜ i Xu i i ⎟ ⎬⎪
⎪⎜
⎪ ⎜⎝ E ⎛⎜⎝ X i2 ⎞⎟⎠ ⎟⎟
⎩⎪ ⎠ ⎪⎪⎭

⎧ 2 ⎫
⎪
µX ⎡ µ ⎤ ⎪
⎪⎪ 2 2 2 ⎪⎪
=E u −2 ⎨ i X u + ⎢ ⎛ 2 ⎞ ⎥ X i ui ⎬
2
i i
X
⎪
⎪ E ⎛⎜⎝ X i2 ⎞⎟⎠ ⎢⎣ E ⎜⎝ X i ⎟⎠ ⎥⎦ ⎪
⎪
⎪⎩ ⎪⎭
2
µ ⎡ ⎤
⎡ µ ⎤ ⎡ 2 ⎛ 2 ⎞⎤
= E u − 2 ⎛ X 2 ⎞ E ⎢ X i E ⎝⎛⎜ ui2| X i ⎠⎞⎟ ⎥ + ⎢
⎛ 2⎞
⎜⎜ i ⎟⎟
X
⎥ E ⎢ X i E ⎜⎝ ui | X i ⎟⎠ ⎥
⎣⎢ ⎛ 2⎞ ⎦⎥ ⎣⎢ ⎦⎥
⎝ ⎠
E ⎜⎝ X i ⎟
⎠
⎢⎣ E ⎜⎝ X i ⎟⎠ ⎥⎦
2
µ ⎡ µ ⎤ ⎛ 2⎞
= σ − 2 ⎛ X 2 ⎞ µ σ u2 + ⎢
2
u
X
⎥ E ⎜⎜ X i ⎟⎟σ u2
X
⎛ 2⎞
E ⎜⎝ X i ⎟
⎠
⎢⎣ E ⎜⎝ X i ⎟⎠ ⎥⎦ ⎝ ⎠

⎛ µ2 ⎞
= ⎜1 − ⎛ X 2 ⎞ ⎟σ u2 .
⎜ E ⎜ Xi ⎟ ⎟
⎝ ⎝ ⎠⎠

Because E ( H i ui ) = 0, var ( H i ui ) = E[( H i ui ) 2 ], so

⎛ µ X2 ⎞ 2
var (H i ui ) = E[( H i ui ) 2 ] = ⎜1 − ⎟σ .
⎜ E ( X i2 ) ⎟ u
⎝ ⎠

Also (continued next page)

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 14
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5.12 (continued)

⎧⎛ ⎞ 2 ⎫⎪ ⎧ 2 ⎫
⎪⎜
µX ⎪
µX ⎡ µ ⎤ ⎪
E ( H i2 ) = E 1 −
⎟
⎪⎪ ⎜ ⎟ ⎪⎪ ⎪⎪ 2 ⎪⎪
X = E 1− 2 X + ⎢ X
⎥ X
E ( X i2 ) E ( X i2 ) ⎢⎣ E ( X i ) ⎥⎦
⎨⎜ i ⎟ ⎬⎪ ⎨ i i ⎬⎪
⎪⎜ ⎪ 2
⎟⎟
⎪ ⎜⎝ ⎠ ⎪⎪⎭ ⎪ ⎪
⎩⎪ ⎩⎪ ⎭⎪
2
µ X2 + ⎡ µ X ⎤ E X 2 = 1− µ X2 .
=1− 2 2
⎢ 2
⎥
E ( Xi
i
) ⎢⎣ E ( X i ) ⎥⎦
2 ( ) E ( Xi )
Thus

⎛ µX2 ⎞ 2
⎜1 − ⎟σ
var (H i ui ) ⎜ E ( X i2 ) ⎟ u σ u2
σ β2ˆ = =⎝ ⎠ =
⎡ nE ( H 2 )2 ⎤ ⎛
2
⎛ µX2 ⎞
µX2 ⎞
0

⎢⎣ i ⎥⎦ n⎜1 − ⎟ n ⎜1 − ⎟
⎜ E ( X i2 ) ⎟ ⎜ E ( X i2 ) ⎟
⎝ ⎠ ⎝ ⎠
E ( X i2 )σ u2 E ( X i2 ) σ u2
= = .
n[ E ( X i2 − µ X2 )] nσ X2

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 15
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5.13. (a) Yes, this follows from the assumptions in KC 4.3.

(b) Yes, this follows from the assumptions in KC 4.3 and conditional
homoskedasticity

(c) They would be unchanged for the reasons specified in the answers to those
questions.

(d) (a) is unchanged; (b) is no longer true as the errors are not conditionally
homosckesdastic.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 16
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5.14. (a) From Exercise (4.11), βˆ = ∑ aiYi where ai =

Xi
. Since the weights depend
∑ j=1 X 2j
n

only on X i but not on Yi , β̂ is a linear function of Y.

∑ i=1
n
X i E(ui |X 1 ,…, X n )
(b) E( β̂ |X 1 ,…, X n ) = β + = β since E (ui | X1 , K , X n ) = 0
∑ i=1
n
X 2j

∑ i=1
n
X i 2Var (ui |X 1 ,…, X n ) σ2
(c) Var ( β̂ |X 1 ,…, X n ) = =
⎡ ∑ i=1
n
X 2j ⎤⎦
2
∑ i=1
n
X 2j
⎣

(d) This follows the proof in the appendix.

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 Stock/Watson - Introduction to Econometrics - 3rd Updated Edition - Answers to Exercises: Chapter 5 17
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5.15. Because the samples are independent, βˆm ,1 and βˆw,1 are independent. Thus

var ( βˆm,1 − βˆw,1 ) = var ( βˆm,1 ) + var( βˆw,1 ). Var ( βˆm,1 ) is consistently estimated as

[ SE ( βˆm,1 )]2 and Var (βˆw,1 ) is consistently estimated as [ SE ( βˆw,1 )]2 , so that

var( βˆm,1 − βˆw,1 ) is consistently estimated by [ SE ( βˆm,1 )]2 + [ SE ( βˆw,1 )]2 , and the result
follows by noting the SE is the square root of the estimated variance.

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