Econometrics For Finace Lecture I
Econometrics For Finace Lecture I
By:
Amsalu B. (MSc.)
Unity University
Email: [email protected]
The regression line fits the data quite well; since MPC is 0.70;
increase in real income of 1 birr led, on average, to an increase of
about 70 percents in real consumption.
Note: A hat symbol (^) above one variable will signify an
estimator of the relevant population value
Cont’d
The estimated regression line is
Cont’d
Hypothesis Testing: is a tool for making statistical inferences
about the population data.
It provides a way to verify whether the results of an experiment
are valid.
Keynes postulated the MPC to be positive but less than 1.
The MPC to be about 0.70. But before we accept the MPC = 0.70
as confirmation of Keynesian consumption theory, we must
enquire whether this estimate is sufficiently below unity.
Such confirmation or refutation of economic theories on the
basis of sample evidence is called as statistical inference
(hypothesis testing).
Cont’d
Forecasting or Prediction: is an estimation of a future
events. That means, With given future value(s) of X, what is
the future value(s) of Y?
Suppose, we want to predict the mean consumption
expenditure for 1997. The GDP value for 1997 was 7269.8 billion
birr, consumption would be: Yˆ1997 = 184.0779 + 0.7064
(7269.8) = 5319.5. However, the actual value of the consumption
expenditure reported in 1997 was 5313.5 billion birr.
Cont’d
Using model for control or policy purposes: Suppose further the
government believes that consumer expenditure of about 4,900 will
keep the unemployment rate at its current level of about 4.2%. What
level of income will guarantee the target amount of consumption
expenditure?
Simple arithmetic will show that: 4,900 = 184.0779 + 0.7064X.
X = 6,675, approximately. An income level of about 6675 (billion)
birr, given an MPC of about 0.70, will produce an expenditure of
about 4,900 billion birr.
By appropriate fiscal and monetary policy mix, the government can
manipulate the control variable X to produce the desired level of the
target variable Y.
Desirable Properties of an Econometric Model
An econometric model is a model whose parameters have
been estimated with some appropriate econometric technique.
The ‘goodness’ of an econometric model is judged customarily
according to the following desirable properties.
Theoretical plausibility: The model should be compatible
with the postulates of economic theory. It must describe
adequately the economic phenomena to which it relates.
Explanatory ability: The model should be able to explain the
observations of the actual world. It must be consistent with the
observed behavior of the economic variables whose relationship
it determines.
Cont’d
Accuracy of the estimates of the parameters: The estimates
of the coefficients should be accurate in the sense that they
should approximate as best as possible the true parameters of
the structural model.
The estimates should if possible possess the desirable properties
of unbiasedness, consistency and efficiency.
Forecasting ability: The model should produce satisfactory
predictions of future values of the dependent (endogenous)
variables.
Cont’d
Simplicity: The model should represent the economic
relationships with maximum simplicity.
The fewer the equations and the simpler their mathematical
form, the better the model is considered, ceteris paribus (that is
to say provided that the other desirable properties are not
affected by the simplifications of the model)
1.4. The Goals or Purpose of Econometrics
Econometrics help us to achieves the following three
goals:
Analysis: Judge the validity of the economic theories.
Policy making: Supply the numerical estimates of the
coefficient of the economic relationships which may be then
used for some sound economic policies.
Forecasting: Forecast the future values of the economic
magnitude with certain degree of probability.
Econometric Types of Data
Time series data: a time series data set consists of observations
on a variable or several variables over time.
Ordering of observations conveys important information
Data frequency: daily, weekly, monthly, quarterly, annually
Typical features of time series: trends and seasonality
Typical applications: applied macroeconomics and finance
Examples of time series data include stock prices, money
supply, consumer price index, gross domestic product, and
automobile sales figures.
Because past events can influence future events and lags in
behavior are prevalent in the social sciences, time is an important
dimension in time series data set.
Cont’d
Property tax
Size of house
in square feet
Number of bathrooms
Before reform
After reform
Panel or Longitudinal Data
The data are also called micro panel data is a special type of
pooled data in which the same cross-sectional unit (say, a
family or a firm) is surveyed over time.
Panel data have space as well as time dimensions.
There are other names for panel data, such as pooled data (time
series and cross-sectional data), combination of time series and
cross-section data, micro panel data, longitudinal data (a study
over time of a variable or group of subjects), event history
analysis (studying the movement over time of subjects through
successive states or conditions), cohort analysis (following the
career path of 1965 graduates of a business school).
Cont’d
Example: City crime statistics; each city is observed in two years, time-
invariant unobserved city characteristics may be modeled, effect of police on
crime rates may exhibit time lag.
Number of
police in 1986
Number of
police in 1990
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