Problem Set 6

November 23, 2015

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Problems 4.1-4.5

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3
Problem 4.6

We know that the true data-generating process is

Yi = 0 + 1 Xi + ui

and now we have to find E[Yi |Xi ]. Then we can simply plug in

E[Yi |Xi ] = E[ 0 + 1 Xi + ui |Xi ]

= 0 + 1 E[Xi |Xi ] + E[ui |Xi ]
= 0 + 1 Xi +0
= 0 + 1 Xi

Problem 4.7

I’m going to use X to denote the statement “conditional on all Xi ’s.” This means exactly what you
think it does...that we’re fixing the values of the regressors Xi .

You should be able to show for youself at this point that E[ ˆ1 |X ] = 1. Take the definition of ˆ0 :

ˆ0 = Ȳ ˆ1 X̄

and to find E[ ˆ0 |X ] just plug in

E[ ˆ0 |X ] = E[Ȳ ˆ1 X̄|X ]

= E[( 0 + 1 X̄ + ū) ˆ1 X̄|X ]

where in the second line I substitute 0 + 1 Xi + ui for Yi and take the sample average. Then

E[ ˆ0 |X ] = E[Ȳ ˆ1 X̄|X ]

= E[( 0 + 1 X̄ + ū) ˆ1 X̄|X ]

= 0 + 1 E[X̄|X ] + E[ū|X ] E[ ˆ1 X̄|X ]

= 0 + 1 X̄ +0 X̄E[ ˆ1 |X ]
= 0 + 1 X̄ +0 X̄ 1

= 0

where from the third to fourth line I substitute 0 for E[ū|X ] (This follows from E[ui |X ] = 0. You
should be able to show this for your self), and in the second-to-last line I substitute 1 for E[ ˆ1 |X ],
which we know initially.

Problem 4.8

We know that the true data-generating process is

Yi = 0 + 1 Xi + ui

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where E[ui |Xi ] = 2. Let’s re-write the equation above and make a clever substitution:

Yi = + 2+ 1 Xi + (ui 2)
| 0{z } | {z }
˜0 ũi

Notice that Yi and Xi now satisfy a TRUE regression model

Yi = ˜0 + 1 Xi + ũi

where E[ũi |Xi ] = E[ui 2|Xi ] = E[ui |Xi ] 2 = 2 2 = 0. This “˜” model above satisfies all assumptions
of Key Concept 4.3, so all parts of Key Concept 4.4 hold for the “˜”-model.

Then ˆ1 is normally-distributed N ( 1,
2
ˆ1 ) where

2 1V ar((Xi µX )ũi )
ˆ1 =n
V ar(Xi )

(OK, technically we would need to show whether V ar((Xi µX )ũi ) remains the same as in the original
model, but the question didn’t intend for you to go that far, so just forget about it for now...) and ˆ0
is normally-distributed N ( ˜0 , 2 ) where 2 is the same as before.
ˆ0 ˆ0

The only thing that changes is that ˆ0 is now distributed N ( ˜0 , 2

ˆ0 ) with a mean of ˜0 = 0 + 2, not
mean of 0.

Problem 4.9

Part a.

ESS
R2 =
T SS
P
(ŷ ȳ)2
= P i
(yi ȳ)2
P ¯2
(ŷ ŷ)
= P i
(yi ȳ)2

Remember that we define ŷi = ˆ0 + ˆ1 Xi so that

P ¯2 P ˆ
(ŷ ŷ) ( 0 + ˆ1 Xi ( ˆ0 + ˆ1 X̄))2
P i = P
(yi ȳ)2 (yi ȳ)2
P ˆ
( 1 (Xi X̄))2
= P
(yi ȳ)2
P 2
= ˆ2 P(Xi X̄)
1 2
(yi ȳ)

Then ˆ1 = 0 ) R2 = 0.

Part b.

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 P 2 P
We have that R2 = ˆ12 P(X i X̄) ˆ
(yi ȳ)2 . Then the only way that R = 0 is if 1 = 0 OR if
2
(Xi X̄)2 = 0.
P
But if (Xi X̄) = 0, then all the Xi satisfy Xi = X̄ , which is a single value. In this case, ˆ1 is
2

not well-defined, and neither is R2 .

So R2 = 0 implies that either ˆ1 = 0 OR that all of the regressors Xi take on a single value, and the
best fit OLS line is vertical.

Problem 4.10

Problem 4.11

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Problem 4.12

Problem 4.13

We have gone through the derivation of the variance

2 1V ar((Xi µX )ui )
ˆ1 =n
V ar(Xi )

when the model is Yi = 0 + 1 Xi + ui

Now our regression model is

Yi = 0 + 1 Xi + ui

so we make a substitution

Yi = 0 + 1 Xi + ui
|{z}
ũi
= 0 + 1 Xi + ũi

where E[ũi |Xi ] = E[ui |Xi ] = 0. Then the same derivation of variance applies, and the final answer

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should be

2 1Var((Xi µX )ũi )
ˆ1 = n
V ar(Xi )
V ar((X i µX )ui )
= n 1
V ar(Xi )
V ar((X i µX )ui )
= n 1 2
V ar(Xi )

Problem 4.14

Part B

Part a.

Part i.

We would expect 50% of subjects to receive good A and 50% to receive good B. Out of the ones who
received good B, we would expect all to trade for good A.

Part ii.

We would expect 50% of subjects to receive good A and 50% to receive good B. Out of the ones
who received good B, we would expect 50% to prefer/trade for good A (because goods are distributed
randomly, so that the consumer’s preferences should be independent of the good in question), and out
of the ones who received good A, we would expect 50% to prefer/trade for good B. Hence, we would
expect a total of 50% of subjects to trade.

Part iii.

We would expect 50% of subjects to receive good A and 50% to receive good B. Out of the ones
who received good B, we would expect X% to prefer/trade for good A (because goods are distributed
randomly, so that the consumer’s preferences should be independent of the good in question), and out
of the ones who received good A, we would expect (1 X)% to prefer/trade for good B. Hence, we
would expect a total of X% · 50% + (1 X)% · 50% = 50% of subjects to trade.

Part b.

We see that a fraction 34% of subjects traded. To determine whether it is statistically significantly
different from 50%, we use the t-statistic:

p̂ p0 .34 .5
=p = 8.73
SE(p̂) .34(1 .34)/148

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where p̂ = .34 is the sample proportion of individuals who traded, p0 = .5 is the null hypothesis
p̂ p0
we’re testing, and SE(p̂) is the standard error of p̂ (notice that it is equivalent to write SE(p̂) =
p
148 pp̂ p0 ).
p̂(1 p̂)

The value 8.73 indicates a rejection at the .001-significance level (regardless of whether a one or two-
sided test is used), so the fraction is significantly different from 50%, and there is evidence of an
endowment effect.

Part c.

We see that a fraction 34% of subjects traded. To determine whether it is statistically significantly
different from 50%, we use the t-statistic:

H 0 : p0 = 0

p̂ p0 .34 .5
=p = 4.11
SE(p̂) .34(1 .34)/148
where p̂ = .34 is the sample proportion of individuals who traded, p0 = .5 is the null hypothesis
p̂ p0
we’re testing, and SE(p̂) is the standard error of p̂ (notice that it is equivalent to write SE(p̂) =
p
148 pp̂ p0 ).
p̂(1 p̂)

The value 4.11 indicates a rejection at the .001-significance level (regardless of whether a one or
two-sided test is used), so the fraction is significantly different from 50%, and there is evidence of an
endowment effect.

Part d.

Dealers: We see that a fraction 44.6% of subjects traded. To determine whether it is statistically
significantly different from 50%, we use the t-statistic:

H0 : p0,d = 0

p̂d p0,d .446 .5

=p = .935
SE(p̂d ) .446(1 .446)/74
where p̂d = .446 is the sample proportion of individuals who traded, p0,d = .5 is the null hypothesis
we’re testing, and SE(p̂) is the standard error of p̂d . The value .935 is not rejected at the .1-
significance level (regardless of whether a one or two-sided test is used), so the fraction is NOT
significantly different from 50%, and there is no evidence of an endowment effect among dealers.

Non-Dealers: We see that a fraction 23% of subjects traded. To determine whether it is statistically
significantly different from 50%, we use the t-statistic:

H0 : p0,nd = 0

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 p̂nd p0,nd .23 .5
=p = 5.53
SE(p̂nd ) .23(1 .23)/74
where p̂nd = .23 is the sample proportion of individuals who traded among non-dealers, p0,nd = .5 is
the null hypothesis we’re testing, and SE(p̂nd ) is the standard error of p̂nd . The value 5.53 is rejected
at the .001-significance level (regardless of whether a one or two-sided test is used), so the fraction IS
significantly different from 50%, and there is no evidence of an endowment effect among non-dealers.

Comparison: Now we test whether the proportion of individuals who trade is the same among
dealers and non-dealers:
H0 : p0,d p0,nd = 0
| {z }
p0

p̂d p̂nd p0 .446 .23

= p
SE(p̂d p̂nd ) SE(p̂d )2 + SE(p̂nd )2
.446 .23
= p
.446(1 .446)/74 + .23(1 .23)/74
= 2.85

which yields a rejection at the .01 level for a 2-sided test, so there is evidence that experience whittles
down the endowment effect.

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