Polytechnic University of the Philippines

Sta. Mesa, Manila

ECON 3023 ECONOMETRICS

GROUP PROJECT

Submitted By:

Submitted To:

GROUP 8
Camacho, Irwin Dave
De Ramos, Liezel
Gonzales, Divina
Oliver, Ralph Laurence
B.S. ECONOMICS 3-1

Prof. Alberto Guillo

Vice President for Administration, PUP

ASSUMPTIONS OF SIMPLE AND

MULTIPLE REGRESSION MODEL

ASSUMPTION 1: LINEAR REGRESSION MODEL

Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Nonlinearity in
Parameters

Graphical Approach

Scatterplot

Plot of observed
versus
predicted values
Plot of residuals
versus predicted
values
-Better than the
observed-versuspredicted plot for this
purpose, because it
eliminates the visual
distraction of a sloping
pattern

Statistical Approach

Chow Test

Effect/s of the violation in

the model

The normal equations

for nonlinear
regression have the
unknowns (the Bs)
both on the left and
right-hand sides of the
equations.
As a consequence, we
cannot obtain explicit
solutions of the
unknowns in terms of
the known quantities.

Wrong regressors

Changing parameters

Remedial Measures

Perform a curvilinear
transformation

If there appears to be
a quadratic pattern to
the residuals,
polynomial
transformation of
degree 2 should be
tried.

Log transformation

Locally Weighted
Scatterplot Smoothing
(LOWESS)

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Does High Public Debt

Consistently Stifle
Economic Growth?
A Critique of Reinhart
and Rogoff

Authors &
Institutional
Affiliations:
-Thomas Herndon
-Michael Ash
-Robert Pollin
-Political Economy
Research Institute, University of
Massachusetts
Amherst
Publication/Journal
Title:
-Working Paper Series

 Date of Publication,
Volume No. and Year:
-April 2013, Number
322
Violation:
-Nonlinear
relationship between
the variables
How was it detected:
-Scatterplot
Remedial Measure:
-LOWESS

ASSUMPTION 2: X VALUES ARE FIXED IN REPEATED SAMPLING

Graphical Approach

Departures from/ Violations

of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Stochastic regressor(s)

Endogeneity

Graphically examining
the cumulative sum of
the recursive residuals

Statistical Approach

Durbin-Wu-Hausman
Specification Test

Johansen Test

Engle-Granger twostep method

Effect/s of the violation in

the model

Simultaneous
equation or
simultaneity problem
The estimates of the
slope and intercept
will be biased

Remedial Measures

Use of Proxy variable

Instrumental Variable
(IV) Regression

Clever Sample
Selection.

Drop the polluted

observations of X that
covary with the
disturbance

Instrumental Variables
or Control Variables.
In each observation,
drop the polluted
component of X or
control for the polluted
component of X.

Full Information
Methods.
Model the covariation of
errors across the
equations.

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Foreign Direct
Investment Inflows
and Economic Growth
in Ghana

Author:
-Baba Insah
Publication/Journal
Title:
-International Journal
of Economic Practices
and Theories
Date of Publication,
Volume No. and Year:
-April 2013, Vol.3,
No.2
Violation:
-Stochastic regressors

 How was it detected:

-Johansen Test
Remedial Measure:
-Engle-Granger twostep methodology for
error correction was
employed
-Error Correction was
utilized.

ASSUMPTION 3: ZERO MEAN VALUE OF DISTURBANCE ui

Graphical Approach

Departures from/ Violations

of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Nonzero mean of ui

Plot of residuals
against the
predictor(s)

if there are more than

a couple of
predictors, at least
against fitted values

Statistical Approach

Cobb-Douglas
Function

Effect/s of the violation in

the model

The coefficient
estimate gets biased
down

Remedial Measures

Randomization of the
measurement order
Randomization can
effectively convert
systematic
measurement errors
into additional
random process error.
While adding to the
random error of the
process is undesirable,
this will provide the
best possible
information from the
data about the
regression function.
Using additional
information
Redesigning the
measurement system

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Consumption of
Tobacco and
Alcoholic Beverages
Among Spanish
Consumers

Authors &
Institutional
Affiliations:
-Anna-Lena Beutel
- Stefan Minner
-Department of
Business
Administration,
University of Vienna,
Austria

to eliminate the
systematic errors

Reformulating the
problem to obtain the
needed information
the other way

Publication/Journal
Title:
-International Journal
of Production
Economics
Date of Publication &
Volume No:
2011
Violation:
-non zero mean of
error
How was it detected:
-Using plot of
disturbance
Remedial Measures
-Used service level
model which performs
better for the target
fill rate than for instock probabilities

ASSUMPTION 4: HOMOSCEDASTICITY OR EQUAL VARIANCE OF

Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Heteroscedasticity

Graphical Approach

Scatterplot

look for any pattern:

Statistical Approach

Park Test

Gives equal weight to

all observations

Breush-Pagan / CookWeisberg Test for

Heteroscedasticity

Standard errors are

biased

No heteroscadasticity
Not Linear and nature
is unknown

Linear increase and

presence of
heteroscadasticity

Heteroscadasticity
with quadratic
relationship

Effect/s of the violation in

the model

White General Test

for Heteroscedasticity
Goldfeld-Quandt Test

Remedial Measures

Respectify the Model/

Transform the
Variable

Use Robust Standard

Error (also referred as
Huber/White
estimators or
sandwich estimators
of variance)

This in turn leads to

bias in test statistics
and confidence
intervals

Use Weighted Least

Square

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Meta-analysis of
alcohol price and
income elasticities
with corrections for
publication bias

Authors &
Institutional
Affiliations:
-Jon P. Nelson
Publication/Journal
Title:
-Nelson Health
Economics Review

Quadratic relationship
Date of Publication &
Volume No:
2013, 3:17

 Violation:
-Heteroscedasticity

How was it detected:

-Scatterplot; a
funnel-shaped plot
was detected
Remedial Measures:
-Dividing equation (1)

by the standard error

to yield

where ti is the tstatistic for the i-th

observation, 1/Sei is
its precision, and vi is
an error term
corrected for
heteroscedasticity.

ASSUMPTION 5: NO AUTOCORRELATION BETWEEN THE DISTURBANCES

Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Autocorrelated
Disturbances

Graphical Approach

Time sequence plot

Residuals plots

Statistical Approach

The Runs Test

The Durbin Watson

Test

Effect/s of the violation in

the model

The Breusch Godfrey

the OLS estimator is

unbiased
the OLS estimator is
inefficient; that is, it is
not BLUE

The estimated
variances and
covariances of the OLS
estimates are biased
and inconsistent

If there is positive
autocorrelation, and if
the value of a righthand side variable
grows over time, then
the estimate of the
standard error of the
coefficient estimate of
this variable will be

Remedial Measures

Cochrane-Orcutt
estimator

Hildreth-Lu estimator

AUTOREG Procedure

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

An Examination of
Socioeconomic
Determinants of
Average Body Mass
Indices in Rwanda

Authors &
Institutional
Affiliations:
-Edward Mutandwa
-College of Forest
Resources, Mississippi
State University, USA
Publication/Journal
Title:
-Open Obesity Journal

too low and hence the

t-statistic too high

Hypothesis tests are

not valid.

Date of Publication &

Volume No:
-2015, 7, 1-9

Violation:
-Positive
autocorrelation
How was it detected:
-By using DurbinWatson test value,
obtained 0.93,
indicating positive
autocorrelation
(p<0.05)
Remedial Measures:
-By using proc
autoreg

ASSUMPTION 6: ZERO COVARIANCE BETWEEN AND

Graphical Approach

Departures from/ Violations

of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Nonzero covariance
between disturbances
and regressor

Graphically examining
the cumulative sum of
the recursive residuals

Statistical Approach

Durbin-Wu-Hausman
test for endogeneity

Effect/s of the violation in

the model

OLS estimator will be

both biased and
inconsistent
Endogeneity

Remedial Measures

Clever Sample
Selection.

Drop the polluted

observations of X that
covary with the
disturbance

Instrumental Variables
or Control Variables.
In each observation,
drop the polluted
component of X or
control for the polluted
component of X.

Full Information
Methods.
Model the covariation of
errors across the
equations.

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Understanding
Estimators of Linear
Regression Model
with AR (1) Error
Which are Correlated
with Exponential
Regressor
Authors &
Institutional
Affiliations:
-J. O. Oalomi
-A. Ifederu
-Department of
Statistics, University of
Ibadan, Ibadan,
Nigeria

 Publication/Journal
Title:
-Asian Journal of
Mathematics and
Statistics 1 (I)
ISSN 1994-5418
Asian Network for
Scientific Information
Date of Publication &
Volume No:
-2008, 14-23
Violation:
-Autocorrelation
-Nonzero Covariance
between the
explanatory variable
and the error terms
How was it detected:
-Monte Carlo
Approach for the
investigation
Remedial Measures:
-Generalised Least
Square (GLS)
Estimators: CORC,
HILU, ML and MLGRID

and OLS estimation

methods
- Evaluation of the
estimators using finite
sampling properties of
Bias (BIAS), Sum of
Bias of intercept and
slope coefficient
(SBIAS), Variance
(VAR), sum of
variances of intercept
and slope coefficients
(SVAR) and Root
Mean Squared Error
(RMSE) and Sum of
RMSE of intercept and
slope coefficients
(SRMSE)

ASSUMPTION 7: THE NUMBER OF OBSERVATIONS N MUST BE GREATER THAN THE NUMBER OF PARAMETERS TO BE ESTIMATED
Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Sample observations
less than the number
of regressors
Micronumerosity

Graphical Approach

Statistical Approach

When the number of

observations barely
exceeds the number
of parameters to be
estimated, then there
is Near
Micronumerosity

Effect/s of the violation in

the model

Precision of
estimation is reduced

Estimates of may
have large errors
The variance of the
sample mean will be
large.

Will sometimes lead

to accept the
hypothesis = 0
because the ratio of
the sample mean to
its standard error is
small

The estimate of will

be very sensitive to
sample data

Remedial Measures

Increase the sample

size

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Some New Proposed

Ridge Parameters For
the Logistic
Regression Model

Authors &
Institutional
Affiliations:
-Ahlam Abdullah
-Alsomahi
-Lutfiah Ismail Al turk
-Department of
Statistics,
Faculty of Sciences,
King Abdulaziz
University, Kingdom of
Saudi Arabia

The addition of a few

more observations
can sometimes
produce drastic shifts
in the sample mean.

Publication/Journal
Title:
-International Journal
of Development
Research
Date of Publication &
Volume No:
-January, 2015
Vol. 5, Issue, 01, pp. 2
927-2940,
Violation:
-Small sample size n

How was it detected:

-Based on the
resulting estimate.
The variance of the
estimated parameters
is large.

Remedial Measures:
-The sample size is
increased with the
number of
independent variables

ASSUMPTION 8: VARIABILITY IN X VALUES

Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Insufficient variability
in regressors

Graphical Approach

Plot the values of X

and then draw a line
out of the plotted
value of X.

It would be easy if
there is variability in
the values of X.
If it is hard to draw a
specific line
corresponding to the
values of X, then there
is a violation.

Statistical Approach

Formula to test the

variability of X

Effect/s of the violation in

the model

Each values of X
would be equal to the
value of their mean,
and the denominator
of the equation will be
zero, making it
impossible to estimate

Variation in Y would
not be able to explain

( )
=

Remedial Measures

Accurate sample size.

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Household Sample
Surveys in Developing
and Transition
Countries
Measurement error in
household surveys:
sources and
measurement

Authors &
Institutional
Affiliations:
-Daniel Kasprzyk
-Mathematical Policy
Research Washington,
D.C., United States of
America

 Violation:
- Measurement Error
Remedial Measures:
-Quantifying the
existence and
magnitude of a
specific type of
measurement error
requires advance
planning and
thoughtful
consideration
-Nevertheless, if there
is sufficient concern
that the issue may not
be adequately
resolved during survey
preparations or if the
source of error is
particularly egregious
in the survey being
conducted, survey
managers should
takes steps to design
special studies to
quantify the principal
or problematic source
of error.

ASSUMPTION 9: THE REGRESSION MODEL IS CORRECTLY SPECIFIED

Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Model specification
error or Model
specification bias
Omission of a relevant
variable(s)
Inclusion of an
unnecessary
variable(s)
Adopting the wrong
functional form
Errors of
measurement
Incorrect specification
of the stochastic error
term

Graphical Approach

Plot the residuals

against your variables

Noticeable patterns
indicate possible
specification errors.

Statistical Approach

Ramseys Regression
Specification Error
Test (RESET test).
Run your regression
and obtain the
predicted Y
Rerun your regression
with variants of Y on
the right-hand side
Conduct an F-test to
evaluate the joint
significance of the Y
terms
If the F-test indicates
that the Y terms
improve the fit of the
model, then the
model is likely
misspecified

Effect/s of the violation in

the model

If the omitted variable

is correlated with the
included variable,
then the estimates of
the constant and
slope coefficients are
biased and
inconsistent. In other
words, the bias does
not disappear as the
sample size gets larger
If the omitted
variable is not
correlated with the
included variables,
then the slope
coefficient is
unbiased. However,
the coefficient on the
constant term remains

Remedial Measures

Reformulate model

Remove the irrelevant

variable

Transformation of
variables

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

The Asymmetric
Effect of Income on
Import Demand in
Greece

Authors &
Institutional
Affiliations:
-Ionna C. Bardakas
-Bank of Greece
Date of Publication &
Volume No:
-May 2013, No.159
Violation:
-Model Specification
error

biased

The disturbance
variance 2 is
incorrectly estimated
The estimated
variance of the slope
coefficient is a biased
estimator of the
variance of the true
estimator from the
fully-specified model
Confidence intervals
and hypothesis testing
procedures are likely
to give misleading
results about the
significance of
parameters

How was it detected:

-RESET test
Remedial Measures:
-Short-run error
correction equation is
estimated,
insignificant variables
are discarded and a
more parsimonious
specification adopted.

ASSUMPTION 10: THERE IS NO MULTICOLLINEARITY

Departures from/ Violations
of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Multicollinearity

Graphical Approach

Scatterplot

Statistical Approach

Regress and look for a

high R2 but few
significant ratios.

Effect/s of the violation in

the model

All the coefficients

cannot be estimated
precisely
Standard errors will be
infinite.

Remedial Measures

Check for errors or

problematic
computations of
predictor variables.

Eliminate one of the

redundant variables.

Average the
redundant variables.

Transformation of
variables.

New data ( Extend

time series, change
nature or source of
data)
Do nothing

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Population Ageing
and Health Care
Expenditure: New
Evidence on the Red
Herring

Authors &
Institutional
Affiliations:
-Peter Zweifel
-Stefan Felder
-Andreas Werblow
Publication/Journal
Title:
-The Geneva Papers
on Risk and Insurance
Date of Publication &
Volume No:
October 2004, Vol.29
No.4

 Violation:
-Multicollinearity

How was it detected:

-An OLS regression of
the inverse Mills ratio
on the explanatory
variables results in an
R2 of 0.9897,
suggesting almost
perfect linearity
Remedial Measures:
-Multicollinearity is at
least mitigated by
employing a two-part
model in addition to
the Heckman model.
The two-part model
separates the
selection part from
the equation that
explains the level of
HCE. Thus, the
correlation between
the selection term
and the age variables
as a source of
multicollinearity is
eliminated.

ASSUMPTION 11: NORMALITY OF DISTURBANCES

Graphical Approach

Departures from/ Violations

of assumptions (both TwoVariable Linear Model and
Multiple Variable Linear
Model)

Non-normality of
disturbances

Skew
-non-symmetricality
-one tail longer than
the other
Kurtosis
-too flat or too peaked
-kurtosed
Outliers
-individual cases
which are far from the
distribution

Histograms

Boxplots

P-P Plots

Statistical Approach

Anderson-Darling test
of normality

Jarque-Bera test of
normality

Correlation Test
Obtain correlation
between observed
residuals and
expected values under
normality
Compare correlation
with critical value
Reject the null
hypothesis of normal
errors if the
correlation falls below
the table value

Shapiro-Wilk Test

Effect/s of the violation in

the model

In finite samples,
without the normality
assumption the usual
t and F statistics may
not follow the t and F
distributions.

Skew
biases the mean, in
direction of skew
Kurtosis
standard deviation is
biased -and hence
standard errors, and
significance tests

Remedial Measures

Box-Cox
Transformations

Sample of violation with

remedial measures as
discussed in a research
output published in a
professional research
journal
(At least one for each
violation)

Sales Location and

Supply Response
among
Semisubsistence
Farmers in Benin

Authors &
Institutional
Affiliations:
-Hiroyuki Takeshima
-Alex Winter-Nelson
-Development
Strategy and
Governance Division
Publication/Journal
Title:
-International Food
Policy Research
Institute

Discussion Paper
Date of Publication &
Volume No:
-July 2010, 00999

Violation:
-Nonnormality
How was it detected:
-By using Lagrange
Multiplier (LM) test
which is derived from
yhe Jarque Bera test
Remedial Measure/s:
-Certain insignificant
variables are dropped
from each
specification when the
omission of such
variables leads to
stronger evidence of
consistency of the
model, which is
diagnosed by
normality test.