Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Microeconometrics
Based on the textbooks Verbeek: A Guide to Modern Econometrics and Cameron and Trivedi: Microeconometrics Robert M. Kunst robert.kunst@univie.ac.at
University of Vienna and Institute for Advanced Studies Vienna

October 21, 2013

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Outline
Basics Heteroskedasticity Endogenous regressors Maximum likelihood Limited dependent variables Panel data

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Heteroskedasticity: the main issue

If the Gauss-Markov assumptions are relaxed by considering the model y = X + , E(|X ) = 0, but with hi2 equaling one on average though not hi2 1, OLS will usually continue to be unbiased but will not be BLUE. In detail, the consequences are:

V(i |X ) = 2 hi2 ,

There exist more ecient estimators than OLS; The standard errors and variances of b are no more consistently estimated.
University of Vienna and Institute for Advanced Studies Vienna

Microeconometrics

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

The variance of OLS under heteroskedasticity

Instead of (A3) and (A4), impose the weaker conditions A10 E(|X ) = 0. A9 V(|X ) = 2 , diagonal;

For any assumption of the type V(|X ) = 2 , it is easily shown that V(b |X ) = V{(X X )1 X |X } = (X X )1 X V(|X )X (X X )1 = 2 (X X )1 X X (X X )1 , which is generally not 2 (X X )1 .

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Ecient estimation under heteroskedasticity

2 , . . . , h 2 ) is known, one could If the diagonal matrix = diag(h1 N 1 1 1 transform the system by = diag(h1 ): , . . . , hN

1 y

X + y = X + ,

) = 2 IN , i.e. standard conditions. Then, with V( |X Gauss-Markov implies that OLS on the transformed model is BLUE, i.e. the estimator = (X X )1 X y . 1 The operation divides all observed variables by a factor proportional to their standard deviation. This ecient estimator is called weighted least squares.
Microeconometrics University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Genuine WLS is not feasible

Typically, is not known. One may substitute a feasible GLS (fGLS) variant for the weighted least squares (GLS) estimator by assuming a heteroskedasticity model hi2 = h(xi ) and estimating within the parametric function class h(.). h(x ) = exp(x ) is a popular model: functional forms a bit arbitrary. The alternative solution is to use inecient OLS and adjusted standard errors.

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

White-Eicker standard errors

If 2 is unknown, this N N matrix cannot be estimated by 2 , . . . , e 2 ). The K K variance matrix diag(e1 N 2 (X X )1 X X (X X )1 , however, can be estimated by
N

(X X )

(
i =1

ei2 xi xi )(X X )1 .

The square root of the diagonal can be used as standard errors. A degrees-of-freedom correction factor N /(N K ) may improve small-sample properties.

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Testing for heteroskedasticity: LMtype tests

Most heteroskedasticity tests are LM (Lagrange multiplier) tests in NR 2 form. The model is estimated under the null of homoskedasticity, i.e. by OLS. Then, the residuals e are regressed on potential causes of heteroskedasticity ei2 = zi + vi , where z may coincide with x or dier. Then, NR 2 from this auxiliary regression becomes a test statistic. Under the null of homoskedasticity, it is distributed 2 (M ) in large samples, with M varying across specications. Running the auxiliary regression with log ei2 as the dependent variable may appear attractive, as it corresponds to the models used for fGLS, but this is not generally supported in the literature.
Microeconometrics University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Popular tests for heteroskedasticity

Three specications are widespread concerning the regressors z in the approximate LM test:

The tted value y from the main regression. This is a variant of the test by Breusch and Pagan, while their original suggestion is rarely used. Here, M = 1; A list of specied covariates z . This is another variant of the Breusch-Pagan test, where M is the dimension of z ; Additional to z , all squares and cross-products among the covariates are added to the auxiliary regression. This is the White test, with M dened by the number of regressors in the auxiliary regression, i.e. M can be large.

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna

Basics

Heteroskedasticity

Endogenous regressors

Maximum likelihood

Limited dependent variables

Panel data

Microeconometrics

University of Vienna and Institute for Advanced Studies Vienna