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Quantitative Methods in Economics Linear Predictor: Maximilian Kasy
Quantitative Methods in Economics Linear Predictor: Maximilian Kasy
Quantitative Methods in Economics Linear Predictor: Maximilian Kasy
Maximilian Kasy
Harvard University
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Linear Predictor
Roadmap, Part I
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Linear Predictor
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Linear Predictor
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Linear Predictor
Some definitions
Ŷ = β0 + β1 X , min E (Y − Ŷ )2
β0 ,β1
I Inner Product:
hY , X i = E (YX )
I Norm:
||Y || = hY , Y i1/2 , min ||Y − Ŷ ||2
β0 ,β1
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Linear Predictor
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Linear Predictor
hY − Ŷ , 1i = 0, hY − Ŷ , X i = 0
I Substitute:
hY − β0 1 − β1 X , 1i = hY , 1i − β0 h1, 1i − β1 hX , 1i = 0,
hY − β0 1 − β1 X , X i = hY , X i − β0 h1, X i − β1 hX , X i = 0
E (Y ) − β0 − β1 E (X ) = 0, E (YX ) − β0 E (X ) − β1 E (X 2 ) = 0
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Linear Predictor
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Linear Predictor
I Solution:
E (YX ) − E (Y )E (X ) Cov(Y , X )
β0 = E (Y ) − β1 E (X ), β1 = =
E (X 2 ) − E (X )E (X ) Var(X )
I Notation:
E ∗ (Y | 1, X ) = β0 + β1 X
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Linear Predictor
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Linear Predictor
ŷi = b0 + b1 xi
n
1
min
b0 ,b1 n
∑ (yi − ŷi )2
i =1
I Inner Product:
n
1
hy , x i = ∑ yi xi
n i =1
I Minimum Norm:
min ||y − b0 x0 − b1 x ||2
b0 ,b1
hy − ŷ , x0 i = 0, hy − ŷ , x i = 0
ȳ − b0 − b1 x̄ = 0, yx − b0 x̄ − b1 x 2 = 0,
I where
n n n
1 1 1
ȳ =
n
∑ yi , yx =
n
∑ yi xi , x2 =
n
∑ xi2
i =1 i =1 i =1
I Solve:
yx − ȳ x̄
b0 = ȳ − b1 x̄ , b1 =
x 2 − x̄ x̄
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Linear Predictor
Goodness of fit
I Back to the population problem.
I How well does X predict Y ?
I Average squared prediction error:
I Goodness of fit:
2 ||Y − E ∗ (Y |1, X )||2 2
1 − Rpop = , 0 ≤ Rpop ≤1
||Y − E (Y )||2
I Sample Analog:
||y − (ŷ | 1, x )||2
R2 = 1 − , 0 ≤ R2 ≤ 1
||y − ȳ ||2
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Linear Predictor
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Linear Predictor
Omitted variables
E ∗ (Y | 1, X1 , X2 ) = β0 + β1 X1 + β2 X2 (Long )
E ∗ (Y | 1, X1 ) = α0 + α1 X1 (Short )
E ∗ (X2 | 1, X1 ) = γ0 + γ1 X1 (Aux )
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Linear Predictor
U ≡ Y − E ∗ (Y | 1, X1 , X2 ),
I so that
Y = β0 + β1 X1 + β2 X2 + U with U ⊥ 1, U ⊥ X1 , U ⊥ X2
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Linear Predictor
Solution
I Substitute:
E ∗ (Y | 1, X1 ) = β0 + β1 X1 + β2 E ∗ (X2 | 1, X1 ) + E ∗ (U | 1, X1 )
= β0 + β1 X1 + β2 (γ0 + γ1 X1 )
= (β0 + β2 γ0 ) + (β1 + β2 γ1 )X1 .
α1 = β1 + β2 γ1
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Linear Predictor
Sample analog
a1 = b1 + b2 c1
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Linear Predictor
ŷ = .0433ST + .00150AFQT + . . .
ŷ = .0502SB + .0528SI + . . .
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