Chapter 7

• Multiple Regression Analysis with

Qualitative Information

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Multiple Regression Analysis with Qualitative Information
• Qualitative Information
• Examples: gender, race, industry, region, rating grade...
• A way to incorporate qualitative information is to use dummy variables.
• They may appear as the dependent or as independent variables.
• A single dummy independent variable

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Multiple Regression Analysis with Qualitative Information
• Graphical Illustration

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Multiple Regression Analysis with Qualitative Information
• Dummy variable trap

• When using dummy variables, one category always has to be omitted:

• Alternatively, one could omit the intercept

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Multiple Regression Analysis with Qualitative Information
• Estimated wage equation with intercept shift

• Does that mean that women are discriminated against?

• Not necessarily. Being female may be correlated with other productivity
characteristics that have not been controlled for.

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Multiple Regression Analysis with Qualitative Information
• Comparing means of subpopulations described by dummies

• Discussion
• It can easily be tested whether the difference in means is significant.
• The wage difference between men and women is larger if no other things are
controlled for; i.e. part of the difference is due to differences in education,
experience, and tenure between men and women.

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Multiple Regression Analysis with Qualitative Information
• Further example: Effects of training grants on hours of training

• This is an example of program evaluation

• Treatment group (= grant receivers) vs. control group (= no grant)
• Is the effect of treatment on the outcome of interest causal?

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Multiple Regression Analysis with Qualitative Information
• Using dummy explanatory variables in equations for log(y)

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Multiple Regression Analysis with Qualitative Information
• Using dummy variables for multiple categories
• 1) Define membership in each category by a dummy variable
• 2) Leave out one category (which becomes the base category)

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Multiple Regression Analysis with Qualitative Information
• Incorporating ordinal information using dummy variables
• Example: City credit ratings and municipal bond interest rates

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Multiple Regression Analysis with Qualitative Information
• Interactions involving dummy variables
• Allowing for different slopes

= intercept men = slope men

= intercept women = slope women

• Interesting hypothesis

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Multiple Regression Analysis with Qualitative Information
• Graphical illustration

Interacting both the intercept

and the slope with the female
dummy enables one to model
completely independent wage
equations for men and women.

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 Multiple Regression Analysis with Qualitative Information
• Estimated wage equation with interaction term

No evidence against hypothesis Does this mean that there is no significant evidence of lower pay for
that the return to education is women at the same levels of educ, exper, and tenure? No: this is only
the same for men and women. the effect for educ = 0. To answer the question one has to recenter the
interaction term, e.g. around educ = 12.5 (= average education).

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Multiple Regression Analysis with Qualitative Information
• Testing for differences in regression functions across groups
• Unrestricted model (contains full set of interactions)

• Restricted model (same regression for both groups)

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Multiple Regression Analysis with Qualitative Information
• Null hypothesis

• Estimation of the unrestricted model

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Multiple Regression Analysis with Qualitative Information
• Joint test with F-statistic

• Alternative way to compute F-statistic in the given case

• Run separate regressions for men and for women; the unrestricted SSR is given
by the sum of the SSR of these two regressions.
• Run regression for the restricted model and store SSR.
• If the test is computed in this way it is called the Chow-Test.
• Important: Test assumes a constant error variance across groups.

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Multiple Regression Analysis with Qualitative Information
• A Binary dependent variable: the linear probability model
• Linear regression when the dependent variable is binary

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Multiple Regression Analysis with Qualitative Information
• Example: Labor force participation of married women

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Multiple Regression Analysis with Qualitative Information
• Example: Female labor participation of married women (cont.)
Graph for nwifeinc=50, exper=5, age=30,
kindslt6=1, and kidsge6=0

The maximum level of education in the

sample is educ=17. For the given case,
this leads to a predicted probability to
be in the labor force of about 50%.

There is a negative predicted

probability, but no problem because no
woman in the sample has educ < 5.

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Multiple Regression Analysis with Qualitative Information
• Disadvantages of the linear probability model
• Predicted probabilities may be larger than one or smaller than zero.
• Marginal probability effects sometimes logically impossible.
• The linear probability model is necessarily heteroskedastic.
• Thus, heteroskedasticity consistent standard errors need to be computed.

• Advantages of the linear probability model

• Easy estimation and interpretation
• Estimated effects and predictions are often reasonably good in practice.

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Multiple Regression Analysis with Qualitative Information
• More on policy analysis and program evaluation
• Example: Effect of job training grants on worker productivity

• Treatment group: grant receivers, Control group: firms that received no grant

• Grants were given on a first-come, first-served basis. This is not the same as giving them out
randomly. It might be the case that firms with less productive workers saw an opportunity to
improve productivity and applied first.

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