Heteroskedasticity vs. Homoskedasticity

Heteroskedasticity
Vs.
Homoskedasticity
Heteroskedasticity:
Definition
Heteroskedasticity is a problem
where the error terms do not have a
constant variance.
E (ei2 )
2
i
That is, they may have a larger

variance when values of some Xi (or
the Yis themselves) are large (or
small).
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Slide 2
Heteroskedasticity
Homoscadesticity
Heteroskedasticity:
Definition
This often gives the plots of the
residuals by the dependent variable
or appropriate independent variables
a characteristic fan or funnel shape.
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Series1
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Slide 5
Reasons of Heteroscedasticity:
Following the error learning models, as people

learn, their errors of behavior become smaller
over time. For example, number of typing error.
As the number of hours put in typing practice
increases, the average number of typing errors
as well as their variances decreases.
As income grow, people have more
discretionary income and hence more scope for
choice about the disposition of their income.
Hence is likely to increase with income.
Improvement of data collecting technique
cases, become decreases.
In the presence of outlier

heteroscedasticity arises.
Due to incorrect specification of
regression model, it arises.
If also arises because of incorrect
transformation and incorrect
functional form.
For skewness of distribution of
regression, it arises.
Consequences of Using OLS in the Presence of

Heteroscedasticity:
The consequences of OLS in the presence of

heteroscedasticity are:
In the presence of heteroscedasticity, still unbiased,
linear, consistent but inefficient.
The OLS estimate is biased and inconsistent i.e. .
The confidence interval based on OLS estimator will be
unnecessary large.
Variance of OLS coefficients will be incorrect i.e. . In this
case we have to estimate -variance from -observations.
That is, one for each variance, a situation in which
estimation is obviously impossible because we cannot
estimate a variance from on observation.
Heteroskedasticity:
Implications (cont.)
The estimator variances are not
asymptotically efficient, and they are
biased.
So confidence intervals are invalid.
What do we know about the bias of the
variance?
If Yi is positively correlated with ei, bias is
negative - (hence t values will be too large.)
With positive bias many t's too small.
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Slide 9
Heteroskedasticity:
Implications (cont.)
Types of Heteroskedasticity
There are a number of types of
heteroskedasticity.
Additive
Multiplicative
ARCH (Autoregressive conditional
heteroskedastic) - a time series problem.
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Slide 10
Heteroskedasticity:
Causes
It may be caused by:
Model misspecification - omitted variable or improper
functional form.
Learning behaviors across time as the number of hours
of typing practice increases, the average number of
typing errors as well as their variances decreases.
Changes in data collection or definitions. companies
with larger profits are generally expected to show
greater variability in their dividend policies than
companies with lower profits. Also, growth oriented
companies are likely to show more variability in their
dividend payout ratio than established companies.
etc).
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Slide 11
Outliers
Outliers or breakdown in model.
An outlying observation, or outlier, is an
observation that is much different (either
very small or very large) in relation to the
observations in the sample. More precisely,
an outlier is an observation from a different
population to that generating the remaining
sample observations.
Frequently observed in cross sectional data
sets where demographics are involved
(population, GNP,
Wrong functional form
Heteroskedasticity: Tests
Informal Methods
Plot the data and look for patterns!
Plot the residuals by the predicted
dependent variable (Resids on the Yaxis)
Plotting the squared residuals actually
makes more sense, since that is what the
assumption refers to!
Homoskedasticity will be a random

scatter horizontally across the plot.
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Slide 14
Graphical Representation
Heteroskedasticity: Tests
(cont.)
Park test
As an exploratory test, log the residuals
and regress them on the logged values of
the suspected independent variable.
l n u i 2 l n 2 B l n X i v i
a B ln X i v i
If the B is significant, then

Heteroskedasticity may be a problem.
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Slide 16
Homoskedasticity: Tests
(cont.)
Goldfeld-Quandt test
Order the n cases by the X that you
think is correlated with ei2.
Drop a section of c cases out of the
middle
(one-fifth is a reasonable number).
Run separate regressions on both upper
and lower samples.
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Slide 17
Heteroskedasticity:
Tests (cont.)
Goldfeld-Quandt test (cont.)

Do F-test for difference in error variances
F-value has (n - c - 2k)/2 degrees of freedom
for each
F n c 2 k
(
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n c 2 k
,
)
2
see1
see2
Slide 18
Whites General
Heteroscedasticity Test:
Consider the following regression

model
The White test procedure as follows

Step-1: By using OLS run and obtain
the residuals .
Step-2: Then we run the following
(auxiliary) regression
Obtaining Robust errors

In regression process on the Robust
errors check so that the error term is
pressed to original one . It will make
data free from hetroscadesticity.
5/1/15
Slide 20

Heteroskedasticity vs. Homoskedasticity

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Heteroskedasticity

That is, they may have a larger

Following the error learning models, as people

In the presence of outlier

Consequences of Using OLS in the Presence of

The consequences of OLS in the presence of

Wrong functional form

Homoskedasticity will be a random

If the B is significant, then

Goldfeld-Quandt test (cont.)

Consider the following regression

The White test procedure as follows

Obtaining Robust errors

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