Chapter 16

Measurement Error Models

A fundamental assumption in all the statistical analysis is that all the observations are correctly measured. In
the context of multiple regression model, it is assumed that the observations on the study and explanatory
variables are observed without any error. In many situations, this basic assumption is violated. There can be
several reasons for such a violation.
 For example, the variables may not be measurable, e.g., taste, climatic conditions, intelligence,
education, ability etc. In such cases, the dummy variables are used, and the observations can be
recorded in terms of values of dummy variables.
 Sometimes the variables are clearly defined, but it is hard to take correct observations. For example,
the age is generally reported in complete years or in multiple of five.
 Sometimes the variable is conceptually well defined, but it is not possible to take a correct
observation on it. Instead, the observations are obtained on closely related proxy variables, e.g., the
level of education is measured by the number of years of schooling.
 Sometimes the variable is well understood, but it is qualitative in nature. For example, intelligence is
measured by intelligence quotient (IQ) scores.

In all such cases, the true value of the variable can not be recorded. Instead, it is observed with some error.
The difference between the observed and true values of the variable is called as measurement error or
errors-in-variables.

Difference between disturbances and measurement errors:

The disturbances in the linear regression model arise due to factors like the unpredictable element of
randomness, lack of deterministic relationship, measurement error in study variable etc. The disturbance
term is generally thought of as representing the influence of various explanatory variables that have not
actually been included in the relation. The measurement errors arise due to the use of an imperfect measure
of true variables.

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Large and small measurement errors
If the magnitude of measurement errors is small, then they can be assumed to be merged in the disturbance
term, and they will not affect the statistical inferences much. On the other hand, if they are large in
magnitude, then they will lead to incorrect and invalid statistical inferences. For example, in the context of
linear regression model, the ordinary least squares estimator (OLSE) is the best linear unbiased estimator of
the regression coefficient when measurement errors are absent. When the measurement errors are present in
the data, the same OLSE becomes biased as well as inconsistent estimator of regression coefficients.

Consequences of measurement errors:

We first describe the measurement error model. Let the true relationship between correctly observed study
and explanatory variables be
y  X 

where y is a  n 1 vector of true observation on study variable, X is a  n  k  matrix of true observations

on explanatory variables and  is a  k  1 vector of regression coefficients. The value y and X are not

observable due to the presence of measurement errors. Instead, the values of y and X are observed with
additive measurement errors as
y  y  u
X  X  V
where y is a  n 1 vector of observed values of study variables which are observed with (n  1)

measurement error vector u . Similarly, X is a (n  k ) matrix of observed values of explanatory variables

which are observed with  n  k  matrix V of measurement errors in X . In such a case, the usual disturbance

term can be assumed to be subsumed in u without loss of generality. Since our aim is to see the impact of
measurement errors, so it is not considered separately in the present case.

Alternatively, the same setup can be expressed as

y  X   u
X  X  V
where it can be assumed that only X is measured with measurement errors V and u can be considered as the
usual disturbance term in the model.

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In case, some of the explanatory variables are measured without any measurement error then the
corresponding values in V will be set to zero.

We assume that
E (u )  0, E (uu ')   2 I
E (V )  0, E (V 'V )  , E (V ' u )  0.

The following set of equations describes the measurement error model

y  X 
y  y  u
X  X  V
which can be re-expressed as
y  y  u
 X   u
  X V    u
 X   u V  
=X   
where   u  V  is called as the composite disturbance term. This model resemble like a usual linear
regression model. A basic assumption in linear regression model is that the explanatory variables and
disturbances are uncorrelated. Let us verify this assumption in the model y  X   w as follows:

E  X  E ( X ) '  E ( )  E V '(u  V  ) 

 E V ' u   E V 'V  
 0  
 
 0.
Thus X and  are correlated. So OLS will not provide efficient result.

Suppose we ignore the measurement errors and obtain the OLSE. Note that ignoring the measurement errors
in the data does not mean that they are not present. We now observe the properties of such an OLSE under
the setup of measurement error model.

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The OLSE is

b X 'X  X 'y

1

b     X ' X  X ' X      
1

  X ' X  X '
1

E  b     E  X ' X  X '  
1
 
  X ' X  X ' E ( )
1

0
as X is a random matrix which is correlated with  . So b becomes a biased estimator of  .

Now we check the consistency property of OLSE. Assume

1 
plim  X ' X    xx
n 
1 
plim  V 'V    vv
n 
1 
plim  X 'V   0
n 
1 
plim  V ' u   0.
n 
Then
  X ' X  1  X '   
plim  b     plim    
 n   n  
1 1
n

X ' X  X  V ' X  V
n
 
1 1 1 1
 X ' X  X 'V  V ' X  V 'V
n n n n
1  1  1  1  1 
plim  X ' X   plim  X ' X   plim  X 'V   plim  V ' X   plim  V 'V 
n  n  n  n  n 
  xx  0  0   vv
  xx   vv

1 1 1
X '   X '   V ' 
n n n
1  1
 X '(u  V  )  V '(u  V  )
n n

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 1  1  1  1  1 
plim  X '    plim  X ' u   plim  X 'V    plim  V ' u   plim  V 'V  
n  n  n  n  n 
 0  0  0  vv 
-1
 X 'X   X ' 
plim  b     plim   plim  
 n   n 
    xx  vv   vv 
1

 0.
Thus b is an inconsistent estimator of  . Such inconsistency arises essentially due to correlation between
X and  .

Note: It should not be misunderstood that the OLSE b   X ' X  X ' y is obtained by minimizing
1

S   '    y  X   '  y  X   in the model y  X    . In fact  '  cannot be minimized as in the case of

usual linear regression, because the composite error   u  V  is itself a function of  .

To see the nature of consistency, consider the simple linear regression model with measurement error as
yi   0  1 xi , i  1, 2,..., n
yi  yi  ui
xi  xi  vi .
Now
1 x1  1 x1   0 v1 
     
1 x2  1 x2  0 v2 
X  , X   , V 
        
     
1 xn  1 xn   0 vn 
and assuming that
1 n 
plim   xi   
 n i 1 
1 n 
plim   ( xi   ) 2    x2 ,
 n i 1 
we have

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 1 
 xx  plim  X ' X 
n 
 1 n 
 1  xi
n i 1 
 plim  n
1 1 n 2
  xi  xi 
 n i 1 n i 1 
1  
 2
.
 x   
2

Also,
1 
 vv  plim  V 'V 
n 
0 0 
 2
.
0 v 
Now

plim  b        xx   vv   vv 
1

1
 b  0  1    0 0   0 
plim  0    2  2  
 b1  1     x     v   0  v   1 
2 2

1   x2   2   v2     0 
 2
 x   v2      2
1    v 
  v2 
 2 1 
v  x2

  .
  2 
  2 v 2 1 
  x v 

Thus we find that the OLSEs of  0 and 1 are biased and inconsistent. So if a variable is subjected to

measurement errors, it not only affects its own parameter estimate but also affect other estimator of
parameter that are associated with those variable which are measured without any error. So the presence of
measurement errors in even a single variable not only makes the OLSE of its own parameter inconsistent but
also makes the estimates of other regression coefficients inconsistent which are measured without any error.

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Forms of measurement error model:
Based on the assumption about the true values of the explanatory variable, there are three forms of
measurement error model .

Consider the model

yi   0  1 xi , i  1, 2,..., n
yi  yi  ui
xi  xi  vi .

1. Functional form: When the xi ' s are unknown constants (fixed), then the measurement error model is

said to be in its functional form.

2. Structural form: When the xi ' s are identically and independently distributed random variables, say, with

mean  and variance  2  2  0  , the measurement error model is said to be in the structural form.

Note that in case of functional form,  2  0.

3. Ultrastructural form: When the xi ' s are independently distributed random variables with different

means, say i and variance  2  2  0  , then the model is said to be in the ultrastructural form. This form is

a synthesis of function and structural forms in the sense that both the forms are particular cases of
ultrastructural form.

Methods for consistent estimation of  :

The OLSE of  which is the best linear unbiased estimator becomes biased and inconsistent in the presence
of measurement errors. An important objective in measurement error models is how to obtain the consistent
estimators of regression coefficients. The instrumental variable estimation and method of maximum
likelihood (or method of moments) are utilized to obtain the consistent estimates of the parameters.

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