Tutorial Session 11 - Heteroscedasticity

Econ 314: Quantitative Economics
Tutorial 10- Heteroscedasticity

Please print and attempt prior to the tutorial session.
1. What is heteroscedasticity? Why is it problematic? Explain in your own words.
2. What are the null and alternative hypotheses for testing for the presence of heteroscedasticity?
Why? Explain.
3. Suppose you are interested in explaining variation in Body Mass Index in a nationally-
representative sample of 12,486 men and women. You estimate the sample regression
function (with D =1 if female and 0 otherwise) as follows (and with standard errors in
parentheses):
�𝑖𝑖 = 26.37 − 5.61 𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝑖𝑖 + 0.48 𝐴𝐴𝐴𝐴𝐴𝐴𝑖𝑖
𝐵𝐵𝐵𝐵𝐵𝐵
(4.62) (1.05) (0.13)
a) Which variable do you suspect could be responsible for heteroscedasticity in this model?
Why? Explain.
b) How would you use Weighted Least Squares to account for heteroscedasticity if it is
present? Explain.
4. Suppose you are interested in explaining variation in Vacation Spending in a sample of

10 000 high-school and university graduates. You estimate the sample regression function
(with D =1 if university graduate and 0 otherwise) (standard errors in parentheses)
𝑉𝑉𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎�
𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖 = 109.82 + 0.12 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑖𝑖 + 317.39 𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈𝑈 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝑖𝑖
(134.62) (0.05) (91.43)
a) Which variable do you suspect could be responsible for heteroscedasticity in this
model? Why? Explain.
b) Suppose you know that heteroscedasticity takes the form ℎ(𝑥𝑥) = 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝑖𝑖2 ∙ 𝜎𝜎 2 . How
would you use Weighted Least Squares to correct for the heteroscedasticity? Explain.
5. You are interested in estimating the money demand function in several countries. You obtain
cross-sectional data for 39 countries for the year 2015, and estimate the following model:
Source | SS df MS Number of obs = 39
-------------+------------------------------ F( 2, 36) = 1123.44
Model | 45.8892902 2 15.2964301 Prob > F = 0.0000
Residual | .476548269 36 .013615665 R-squared = 0.9897
-------------+------------------------------ Adj R-squared = 0.9888
Total | 46.3658385 38 1.22015364 Root MSE = .11669
------------------------------------------------------------------------------
lnmon | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+----------------------------------------------------------------
gdp | 1.227289 .0273449 44.88 0.000 1.171776 1.282802
cpi | .0429665 .0316949 1.36 0.184 -.0213776 .1073105
_cons | -2.27753 .3034308 -7.51 0.000 -2.893527 -1.661532
------------------------------------------------------------------------------
Variables: lnmon the natural log of the broad money stock per capita (in US $)
gdp GDP per capita (in US $)
cpi consumer inflation rate (% change)
Page 1 of 2
You also generated the following graph:
800
600 1000
Squared
400
200
0
2 4 6 8
gdp
a) Identify the specific type of model estimated above.

b) You use the scatter plot above to see whether a suspected problem with your regression
results might exist.
i. Which violation of the assumptions of the Classical Linear Regression Model did you
suspect might affect your results? Describe the nature of the problem briefly.
ii. Explain whether the scatter plot confirms your suspicions.
iii. List two reasons why this problem could occur in your dataset.
c) To remedy for the potential problem, you attempt the following transformation:
. g gdpsqrt=sqrt(gdp)
. g lnmont=lnmon/gdpsqrt
. g gdpt=gdp/gdpsqrt
. g cpit=cpi/gdpsqrt
. g xt=1/gdpsqrt
and you regress the transformed variables lnmont on gdpt, cpit and xt.
What is the assumption that you have made regarding the nature of the pattern/structure
of the problem suspected?
Page 2 of 2

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Econ 314: Quantitative Economics

Tutorial 10- Heteroscedasticity

1. What is heteroscedasticity? Why is it problematic? Explain in your own words.

4. Suppose you are interested in explaining variation in Vacation Spending in a sample of

a) Identify the specific type of model estimated above.

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