INTERPRETING THE RESULTS OF THE LINEAR MODEL

GOODNESS OF FIT, PRACTICAL AND STATISTICAL SIGNIFICANCE

OUTLINE

Estimating linear Interpreting model Practical and statistical

regression in Excel output significance
 RUNNING
REGRESSION

 To run a regression go to Data

> Data Analysis > Regression

 Select the variable to predict in

“Input Y Range”

 Select one or more

explanatory variables into
“Input X Range”; Constant is
added by default

 Tick “Labels” if necessary

INTERPRETING MODEL OUTPUT
 R Square shows percent of variation in price (dependent variable)
“explained” by the model (i.e. included covariates)

 In this case, covariates jointly account for 78.6% of variation in house

prices

 R Square never decreases when additional variable is included

 Hence, we should treat R Square with caution – we are just fitting the
model to data in sample
 PRACTICAL
SIGNIFICANCE
 Overall Quality and Overall
Condition are both measured on
a scale from 1 to 10

 However, 1-step improvement in

Overall Quality has a much bigger
impact on price than 1-step
improvement in Overall Condition
(29490$ vs 720$)

 Hence, Overall Quality has much

higher practical significance
compared to Overall Condition
 PRACTICAL
VERSUS
HOWEVER, A COEFFICIENT IN THIS CASE WE
PRACTICAL MAY BE LARGE BUT CANNOT STATISTICAL
SIGNIFICANCE IS NOT DIFFERENT CONCLUDE ABOUT
NOT THE END OF FROM ZERO IN THE ASSOCIATION
SIGNIFICANCE
THE STORY… STATISTICAL SENSE BETWEEN THE TWO
VARIABLES WHICH
ARE UNRELATED
RULE OF THUMB

 Observe that next to Coefficient there is a Standard

Error

 If we divide Coefficient by its Standard Error we will

obtain t-statistics

 A simple rule of thumb: coefficient is statistically

significant if t-statistics is more than 2 in absolute
value

 Recall: we obtain absolute value of a number by

dropping the sign in front of it
APPLYING THE RULE
OF THUMB

 In our example, Overall Quality

has t-statistics of 45 (statistically
significant) so it is related to
house price in statistical sense

 Overall Condition, on the other

hand, has t-statistics of 1.16 < 2
so that is statistically insignificant

 An equivalent definition:
coefficient is significant at 5% if
its p-value < 0.05
PRACTICAL AND STATISTICAL SIGNIFICANCE

The most interesting case occurs when coefficient is significant in statistical and practical sense - Increase in
Overall Quality by 1 unit is associated with a price increase of 29,490$ (t-statistics of 45)

LotArea is statistically significant (t-statistics = 14.28) but 1 extra square feet has a tiny effect of 1.28$ on
price (not practically significant)

We cannot draw any conclusions about relationship between variables if t-statistics in absolute value is less
than 2

For example, an additional bath could be associated with increase in house price of 1,335$ (not negligible)
but it is not statistically significant (t-statistics of 0.79)
 One of the interesting observations
is that the number of bedrooms is
actually associated with a reduction
of house price by 15,484$! How can
it be?
Number of bedrooms can be
thought of as a measure of house
size, similarly to overall quality, total
living area and number of bathrooms
INTERPRETING COEFFICIENTS
Regression coefficient for a
particular variable can be interpreted
as a net effect after controlling for all
other factors (unlike pairwise
correlations)
Hence, a house with the same
overall quality, total living area and
number of bathrooms may indeed
cost less because clients, for
example, do not like small houses
with many small bedrooms
THANK YOU!

Front and back photo by Scott Graham on Unsplash