Simple Linear Regression

1. review of least squares procedure

2. inference for least squares lines

1
Introduction

• We will examine the relationship between

quantitative variables x and y via a mathematical
equation.
• The motivation for using the technique:
– Forecast the value of a dependent variable (y) from
the value of independent variables (x1, x2,…xk.).
– Analyze the specific relationships between the
independent variables and the dependent variable.
2
The Model
The model has a deterministic and a probabilistic components

House
Cost
bout
o s t sa
u s ec ze)
ho o t. S i
in g a r e fo + 75(
d a
Buil er squ 25000
p =
$75 e cost
Most lots sell s
Hou
for $25,000

House size

3
The Model
However, house cost vary even among same size
houses! Since cost behave unpredictably,
House we add a random component.
Cost

Most lots sell

for $25,000
House cost = 25000 + 75(Size) 
House size

4
The Model
• The first order linear model

yy 00 11xx
y = dependent variable 0 and 1 are unknown population
x = independent variable y parameters, therefore are estimated
from the data.
0 = y-intercept
1 = slope of the line
Rise  = Rise/Run
 = error variable Run
0
x
5
Estimating the Coefficients

• The estimates are determined by

– drawing a sample from the population of interest,
– calculating sample statistics.
– producing a straight line that cuts into the data.
y 
 Question: What should be
 considered a good line?



  

x 6
The Least Squares (Regression) Line

A good line is one that minimizes

the sum of squared differences between the
points and the line.

7
 The Least Squares (Regression) Line
Sum of squared differences = (2 - 1)2 + (4 - 2)2 + (1.5 - 3)2 + (3.2 - 4)2 = 6.89
Sum of squared differences = (2 -2.5)2 + (4 - 2.5)2 + (1.5 - 2.5)2 + (3.2 - 2.5)2 = 3.99
Let us compare two lines
4 (2,4)
 The second line is horizontal
3  (4,3.2)
2.5
2
(1,2) 
 (3,1.5)
1 The smaller the sum of
squared differences
the better the fit of the
1 2 3 4
line to the data.
8
 The Estimated Coefficients
Alternate formula for the slope b1
To calculate the estimates of the slope
and intercept of the least squares line , ssyy
use the formulas: bb11rr s
sxx
SS xy
SS
bb11
xy
SS xx The regression equation that estimates
SS xx
the equation of the first order linear
bb00  yybb11xx model
  xx   
 yy   is:
SS xy
SS xxyy 
 ii ii
ii ii

nn
xy

   xx  
22 ŷŷ  bb00 bb11xx
SS xx
SS  22 
xx  n ((nn1)1)ss
ii 22
xx ii xx
n
9
 The Simple Linear Regression Line

• Example:
– A car dealer wants to find
the relationship between Car Odometer Price
the odometer reading and 1 37388 14636
the selling price of used cars. 2 44758 14122
3 45833 14016
– A random sample of 100 cars 4 30862 15590
is selected, and the data 5 31705 15568
recorded. 6 34010 14718
. .
Independent .
Dependent
– Find the regression line. . .
variable .
x variable y
. . .
10
 The Simple Linear Regression Line
• Solution
– Solving by hand: Calculate a number of statistics
  x
2

x  36,009.45; SS xx   xi
i
2
  43, 528, 690
n

y  14,822.823; SS xy   ( xi yi )  
xi  yi
 2, 712, 511
n
where n = 100.
SS xy 2, 712,511
b1    .06232
(n  1) sx2 43,528, 690
b0  y  b1 x  14,822.82  ( .06232)(36, 009.45)  17, 067

ŷ  b 0  b1x  17,067  .0623x 11

 The Simple Linear Regression Line
• Solution – continued
– Using the computer

1. Scatterplot
2. Trend function
3. Tools > Data Analysis > Regression

12
The Simple Linear Regression Line
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.8063
R Square 0.6501
Adjusted R Square
0.6466
Standard Error 303.1
Observations 100 yˆ  17,067  .0623x
ANOVA
df SS MS F Significance F
Regression 1 16734111 16734111 182.11 0.0000
Residual 98 9005450 91892
Total 99 25739561

CoefficientsStandard Error t Stat P-value

Intercept 17067 169 100.97 0.0000
Odometer -0.0623 0.0046 -13.49 0.0000

13
 Interpreting the Linear Regression
-Equation
17067 Odometer Line Fit Plot

16000

15000
Price

14000

0 No data 13000
Odometer

yˆ  17,067  .0623x

The intercept is b0 = $17067. This is the slope of the line.

For each additional mile on the odometer,
the price decreases by an average of $0.0623
Do not interpret the intercept as the
“Price of cars that have not been driven” 14
Error Variable: Required Conditions

• The error is a critical part of the regression model.

• Four requirements involving the distribution of  must
be satisfied.
– The probability distribution of  is normal.
– The mean of  is zero: E() = 0.
– The standard deviation of  is  for all values of x.
– The set of errors associated with different values of y are all
independent.
15
 The Normality of 
E(y|x3)
The standard deviation remains constant,
0 + 1x3 
E(y|x2)
0 + 1x2 

but the mean value changes with x E(y|x1)

0 + 1x1 

From the
From the first
first three
three assumptions
assumptions we we have:
have:
yy isis normally
normally distributed
distributed with
with mean
mean x1 x2 x3
E(y) == 00 ++ 11x,
E(y) x, and
and aa constant
constant standard
standard
deviation 
deviation
16
Assessing the Model
• The least squares method will produces a
regression line whether or not there is a linear
relationship between x and y.
• Consequently, it is important to assess how well
the linear model fits the data.
• Several methods are used to assess the model.
All are based on the sum of squares for errors,
SSE.

17
 Sum of Squares for Errors
– This is the sum of differences between the points
and the regression line.
– It can serve as a measure of how well the line fits the
data. SSE is defined by
nn
SSE
SSE 
 ( y  ŷ 22 .
)
( y i i ŷ i )i .
i i 11
– A shortcut formula

SSE  yi i b00

SSE   y22 b
yyi i bb11
xxi iyyi i
18
 Standard Error of Estimate
– The mean error is equal to zero.
– If  is small the errors tend to be close to zero
(close to the mean error). Then, the model fits the
data well.
– Therefore, we can, use  as a measure of the
suitability of using a linear model.
– An estimator of  is given by s

SStan
tandard
dard Error
Error of
of Estimate
Estimate
SSE
SSE
ss 
nn22 19
 Standard Error of Estimate,
Example
• Example:
– Calculate the standard error of estimate for the previous
example and describe what it tells you about the model fit.
• Solution

SSE  9, 005, 450

SSE 9, 005, 450
s    303.13
n2 98It is hard to assess the model based
on s even when compared with the
mean value of y.
20
s   303.1 y  14,823
 Testing the slope
– When no linear relationship exists between two
variables, the regression line should be horizontal.

 

 
  

    
        
  
  
     
     
               
    
  
       
     

        


Linear relationship. No linear relationship.

Different inputs (x) yield Different inputs (x) yield
different outputs (y). the same output (y).
The slope is not equal to zero The slope is equal to zero
21
 Testing the Slope
• We can draw inference about 1 from b1 by testing
H0: 1 = 0
H1: 1 = 0 (or < 0,or > 0)
– The test statistic is

b1111
b ss
tt where ssbb11 
ssbb11 SSxxxx
SS
The standard error of b1.

– If the error variable is normally distributed, the statistic

is Student t distribution with d.f. = n-2. 22
 Testing the Slope,
Example
• Example
– Test to determine whether there is enough evidence
to infer that there is a linear relationship between the
car auction price and the odometer reading for all
three-year-old Tauruses in the previous example .
Use  = 5%.

23
 Testing the Slope,
Example
• Solving by hand
– To compute “t” we need the values of b1 and sb1.

b1  .0623
s 303.1
sb1    .00462
(n  1) s x2 (99)(43,528,690)
b1  1  .0623  0
t   13.49
sb1 .00462

– The rejection region is t > t.025 or t < -t.025 with  = n-2 = 98.
Approximately, t.025 = 1.984
24
 Testing the Slope,
Example
• Using the computer
Price Odometer SUMMARY OUTPUT
14636 37388
14122 44758 Regression Statistics
14016 45833 Multiple R 0.8063
15590 30862 R Square 0.6501
15568 31705 Adjusted R Square
0.6466 There is overwhelming evidence to infer
14718 34010 Standard Error 303.1 that the odometer reading affects the
14470 45854 Observations 100
auction selling price.
15690 19057
15072 40149 ANOVA
14802 40237 df SS MS F Significance F
15190 32359 Regression 1 16734111 16734111 182.11 0.0000
14660 43533 Residual 98 9005450 91892
15612 32744 Total 99 25739561
15610 34470
14634 37720 Coefficients
Standard Error t Stat P-value
14632 41350 Intercept 17067 169 100.97 0.0000
15740 24469 Odometer -0.0623 0.0046 -13.49 0.0000
25
 Coefficient of determination
– To measure the strength of the linear relationship we
use the coefficient of determination.




((xx i 
 xx )(
)( yy i 
 yy 



22

RR 
22 i i
2 22
ssxxssyy
2

2  1
2 SSE
SSE
or R
or R  1 

 i ((yy i 
 y
y ))22

Note that the coefficient of determination is r 2

26
 Coefficient of determination

• To understand the significance of this coefficient note:

in p art by The regression model

plained
Ex
Overall variability in y Re
mains
, in par
t, une
xplain
ed The error

27
 Coefficient of determination
y2
Two data points (x1,y1) and (x2,y2)
of a certain sample are shown.

y1 Variation in y = SSR + SSE

x1 x2
Total variation in y = Variation explained by the + Unexplained variation (error)
regression line
28
(y1  y)2  (y 2  y)2  ( ŷ 1  y ) 2  ( ŷ 2  y ) 2  ( y 1  ŷ 1 ) 2  ( y 2  ŷ 2 ) 2
 Coefficient of determination

• R2 measures the proportion of the variation in y

that is explained by the variation in x.

2
R  1
SSE

 ( y i  y ) 2  SSE

SSR
 (y i  y) 2
 (y  y)
i
2
 (y i  y) 2

• R2 takes on any value between zero and one.

R2 = 1: Perfect match between the line and the data points.
R2 = 0: There are no linear relationship between x and y.
29
 Coefficient of determination,
Example
• Example
– Find the coefficient of determination for the used car
price –odometer example.what does this statistic tell you
about the model?
• Solution
– Solving by hand;

  ( xi  x )( yi  y 
2
[ 2,712,511]2
R 
2
2 2
 (43,528,688)(259,996)  .6501
sx s y
30
 Coefficient of determination
– Using the computer
From the regression output we have
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.8063 65% of the variation in the auction
R Square 0.6501 selling price is explained by the
Adjusted R Square
0.6466
Standard Error 303.1
variation in odometer reading. The
Observations 100 rest (35%) remains unexplained by
this model.
ANOVA
df SS MS F Significance F
Regression 1 16734111 16734111 182.11 0.0000
Residual 98 9005450 91892
Total 99 25739561

CoefficientsStandard Error t Stat P-value

Intercept 17067 169 100.97 0.0000 31
Odometer -0.0623 0.0046 -13.49 0.0000
 Using the Regression Equation

• Before using the regression model, we need to

assess how well it fits the data.
• If we are satisfied with how well the model fits
the data, we can use it to predict the values of y.
• To make a prediction we use
– Point prediction, and
– Interval prediction

32
 Point Prediction
• Example
– Predict the selling price of a three-year-old Taurus
with 40,000 miles on the odometer.
A point prediction
ŷ  17067  .0623x  17067  .0623( 40,000)  14,575

– It is predicted that a 40,000 miles car would sell for

$14,575.
– How close is this prediction to the real price?
33
 Interval Estimates
• Two intervals can be used to discover how closely the
predicted value will match the true value of y.
– Prediction interval – predicts y for a given value of x,
– Confidence interval – estimates the average y for a given x.

–– The
The prediction
prediction interval
interval – The confidence interval
11  xx))22
((xxgg  1 ( xg  x ) 2
ˆ  tt 22ss 11
yˆy     yˆ  t 2 s 
nn  ((xxii 
 xx))
22
n  ( x  x )2
i

34
 Interval Estimates,
Example
• Example - continued
– Provide an interval estimate for the bidding price on
a Ford Taurus with 40,000 miles on the odometer.
– Two types of predictions are required:
• A prediction for a specific car
• An estimate for the average price per car

35
 Interval Estimates,
Example
• Solution
– A prediction interval provides the price estimate for a
single car:
1 ( xg  x ) 2
yˆ  t 2 s 1 
n  ( xi  x ) 2
t.025,98
Approximately

1 (40, 000  36, 009) 2

[17, 067  .0623(40000)]  1.984(303.1) 1    14,575  605
100 4,309,340,310

36
 Interval Estimates,
Example
• Solution – continued
– A confidence interval provides the estimate of the
mean price per car for a Ford Taurus with 40,000
miles reading on the odometer.
1 ( x g  x)2
• The confidence interval (95%) = ŷ  t  2 s  
n
 ( x i  x)2

1 (40, 000  36, 009) 2

[17, 067  .0623(40000)]  1.984(303.1)   14,575  70
100 4,309,340, 310

37
The effect of the given xg on the length of
the interval
– As xg moves away from x the interval becomes
longer. That is, the shortest interval is found at x.
ŷ  b 0  b1x g
1 ( x g  x)
2

ŷ  t  2 s  
n (n  1)s 2x

38
The effect of the given xg on the length of
the interval
– As xg moves away from x the interval becomes
longer. That is, the shortest interval is found at x.
ŷ  b 0  b1x g
1 ( x g  x)
2

ŷ  t  2 s  
n (n  1)s 2x
ŷ( x g  x  1)
ŷ( x g  x  1) 1 12
ŷ  t  2 s  
n (n  1)s 2x

x 1 x 1
x
( x  1)  x  1 ( x  1)  x  1
39
The effect of the given xg on the length of
the interval
– As xg moves away from x the interval becomes longer. That is, the
shortest interval is found at x.

ŷ  b 0  b1x g
1 ( x g  x)
2

ŷ  t  2 s  
n (n  1) s 2x

1 12
ŷ  t  2 s  
n (n  1)s 2x

x2 x2 1 22
x ŷ  t  2 s  
n (n  1)s 2x
( x  2)  x  2 ( x  2)  x  2

40
Regression Diagnostics - I

• The three conditions required for the validity of

the regression analysis are:
– the error variable is normally distributed.
– the error variance is constant for all values of x.
– The errors are independent of each other.
• How can we diagnose violations of these
conditions?

41
 Residual Analysis
• Examining the residuals (or standardized
residuals), help detect violations of the required
conditions.
• Example – continued:
– Nonnormality.
• Use Excel to obtain the standardized residual histogram.
• Examine the histogram and look for a bell shaped.
diagram with a mean close to zero.

42
 Residual Analysis
ObservationPredicted Price Residuals Standard Residuals
1 14736.91 -100.91 -0.33
2 14277.65 -155.65 -0.52
3 14210.66 -194.66 -0.65
4 15143.59 446.41 1.48
5 15091.05 476.95 1.58
A Partial list of
For each residual we calculate Standard residuals
the standard deviation as follows:
s ri  s  1  hi where Standardized residual ‘i’ =
1 ( x i  x)2 Residual ‘i’
hi   Standard deviation
n (n  1)s x2

43
 Residual Analysis
Standardized residuals

40
30
20
10
0
-2 -1 0 1 2 More

It seems the residual are normally distributed with mean zero

44
 Heteroscedasticity
• When the requirement of a constant variance is violated we have
a condition of heteroscedasticity.
• Diagnose heteroscedasticity by plotting the residual against the
predicted y. +
^y
++
Residual
+
+ + + ++
+
+ + + ++ + +
+ + + +
+ + + ++ +
+ + + + ^y
+ + ++ +
+ + +
+ + ++
+ + ++

The spread increases with ^y 45

 Homoscedasticity
• When the requirement of a constant variance is not violated we have a
condition of homoscedasticity.
• Example - continued

1000

500
Residuals

0
13500 14000 14500 15000 15500 16000
-500

-1000
Predicted Price

46
Non Independence of Error Variables
– A time series is constituted if data were collected
over time.
– Examining the residuals over time, no pattern should
be observed if the errors are independent.
– When a pattern is detected, the errors are said to be
autocorrelated.
– Autocorrelation can be detected by graphing the
residuals against time.

47
 Non Independence of Error Variables
Patterns in the appearance of the residuals over time indicates
that autocorrelation exists.
Residual Residual

+
+ ++
+
+ + +
+ + +
0 + 0 + +
+ Time Time
+ + + + + +
+
+
+ ++ +
+

Note the runs of positive residuals, Note the oscillating behavior of the
replaced by runs of negative residuals residuals around zero.
48
 Outliers
• An outlier is an observation that is unusually small or large.
• Several possibilities need to be investigated when an outlier
is observed:
– There was an error in recording the value.
– The point does not belong in the sample.
– The observation is valid.
• Identify outliers from the scatter diagram.
• It is customary to suspect an observation is an outlier if its |
standard residual| > 2
49
An outlier An influential observation

+++++++++++
+ +
+ … but, some outliers
+ +
+ +
may be very influential
+
+ + + +
+
+ +
+

The outlier causes a shift

in the regression line

50
 Procedure for Regression Diagnostics
• Develop a model that has a theoretical basis.
• Gather data for the two variables in the model.
• Draw the scatter diagram to determine whether a linear model
appears to be appropriate.
• Determine the regression equation.
• Check the required conditions for the errors.
• Check the existence of outliers and influential observations
• Assess the model fit.
• If the model fits the data, use the regression equation.
51