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ECON102B: Solutions To Problem Set 1: Exercise 2.6
ECON102B: Solutions To Problem Set 1: Exercise 2.6
ECON102B: Solutions To Problem Set 1: Exercise 2.6
EXERCISE 2.6
(a) The intercept estimate b1 240 is an estimate of the number of sodas sold when the
temperature is 0 degrees Fahrenheit. A common problem when interpreting the estimated
intercept is that we often do not have any data points near X 0. If we have no
observations in the region where temperature is 0, then the estimated relationship may not
be a good approximation to reality in that region. Clearly, it is impossible to sell 240
sodas and so this estimate should not be accepted as a sensible one.
The slope estimate b2 6 is an estimate of the increase in sodas sold when temperature
increases by 1 Fahrenheit degree. This estimate does make sense. One would expect the
number of sodas sold to increase as temperature increases.
yˆ 240 6 u 80 240
0 240 6 u x or x 40
300
200
100
SODAS
-100
-200
-300
0 20 40 60 80
TEMP
Figure xr2.6 Graph of regression line for soda sales and temperature
Stanford University 1
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 2.7
(a) Since
Vˆ 2
¦ eˆi2 2.04672
N 2
it follows that
se(b2 ) n
var( b2 ) 0.00098 0.031305
Also,
n Vˆ 2
var(b2 )
¦ ( xi x )2
Thus,
Vˆ 2 2.04672
¦ xi x
2
2088.5
n
var b 0.00098
2
(c) The value b2 0.18 suggests that a 1% increase in the percentage of males 18 years or
older who are high school graduates will lead to an increase of $180 in the mean income
of males who are 18 years or older.
¦ xi x ¦ xi2 N x 2 , we have
2
(e) Since
¦ xi2 ¦ xi x
2
N x2 2088.5 51 u 69.1392 = 245,879
Stanford University 2
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 2.8
E2 x2 E x § x2 x1 ·
2 1 E2 ¨ ¸ E2
x2 x1 x2 x1 © x2 x1 x2 x1 ¹
Thus, bEZ is an unbiased estimator.
§ 1 1 · 2V 2
V2 ¨ ¸
¨ x x x x ¸
2 2
x2 x1
2
© 2 1 2 1 ¹
ª 2V2 º
(d) If ei ~ N 0, V2 , then bEZ ~ N «E2 , »
«¬ x2 x1 »¼
2
Stanford University 3
ECON102B: Solutions to Problem Set 1 Spring 2009
(e) To convince E.Z. Stuff that var(b2) < var(bEZ), we need to show that
x2 x1
2
2V 2 V2
¦ xi x
2
! or that !
x2 x1 ¦ xi x
2 2
2
Consider
x2 x1 ª¬ x2 x x1 x º¼ x2 x x1 x 2 x2 x x1 x
2 2 2 2
2 2 2
Thus, we need to show that
N
2¦ xi x ! x2 x x1 x 2 x2 x x1 x
2 2 2
i 1
or that
N
x1 x x2 x 2 x2 x x1 x 2¦ xi x ! 0
2 2 2
i 3
or that
N
ª¬ x1 x x2 x ¼º 2¦ xi x ! 0.
2 2
i 3
This last inequality clearly holds. Thus, bEZ is not as good as the least squares estimator.
Rather than prove the result directly, as we have done above, we could also refer Professor
E.Z. Stuff to the Gauss Markov theorem.
Stanford University 4
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 2.10
(b)
General General Exxon-
Firm Microsoft IBM Disney
Electric Motors Mobil
b2 Eˆ j 1.430 0.983 1.074 1.268 0.959 0.403
The stocks Microsoft, General Motors and IBM are aggressive with Microsoft being the
most aggressive with a beta value of Eˆ 2 1.430 . General Electric, Disney and Exxon-
Mobil are defensive with Exxon-Mobil being the most defensive since it has a beta value
of Eˆ 2 0.403.
(c)
General General Exxon-
Firm Microsoft IBM Disney
Electric Motors Mobil
b1 = Dˆ j 0.010 0.006 -0.002 0.007 -0.001 0.007
All the estimates of Dˆ j are close to zero and are therefore consistent with finance theory.
In the case of Microsoft, Figure xr2.10 illustrates how close the fitted line is to passing
through the origin.
.5
.4
.3
.2
MSFT-RKFREE
.1
.0
-.1
-.2
-.3
-.4
-.20 -.15 -.10 -.05 .00 .05 .10
MKT-RKFREE
Stanford University 5
ECON102B: Solutions to Problem Set 1 Spring 2009
Stanford University 6
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 2.13
(a)
11
10
5
1990 1995 2000 2005
FIXED_RATE
140
120
100
80
60
40
20
90 92 94 96 98 00 02 04
SOLD
Stanford University 7
ECON102B: Solutions to Problem Set 1 Spring 2009
(a)
2400
2000
1600
1200
800
400
90 92 94 96 98 00 02 04
STARTS
2400
2000
1600
STARTS
1200
800
400
5 6 7 8 9 10 11
FIXED_RATE
Figure xr2.13 (d) Fitted line and observations for housing starts against the fixed rate
Stanford University 8
ECON102B: Solutions to Problem Set 1 Spring 2009
The coefficient 13.034 suggests that a 1% increase in the 30 year fixed interest rate for
home loans is associated with a decrease of around 13,034 houses sold. The intercept
suggests that when the 30 year fixed interest rate is 0%, 167,548 houses will be sold over a
period of 1 month. Caution should be exercise with this interpretation, however, because it
is beyond the range of the data.
140
120
100
SOLD
80
60
40
20
5 6 7 8 9 10 11
FIXED_RATE
Figure xr2.13(e) Fitted line and observations for houses sold against fixed rate
Figure xr2.13(e) shows us where the fitted line lies amongst the data points. From this
figure we can see that the data appear slightly convex relative to the fitted line suggesting
that a different functional form might be suitable. A plot of the residuals against the fixed
rate might shed more light oin this question. We can see also that the residuals appear to
have a constant distribution over the majority of fixed rates.
(f) Using the model estimated in part (c), the predicted number of monthly housing starts for
FIXED _ RATE 6 is
STARTS
n u 1000 2992.739 194.233 u 6 u 1000 1827.34 u 1000 1,827,340
There will be 1,827,340 new privately owned houses started at a 30 year fixed interest rate
of 6%. This is a seasonally adjusted annual rate. On a monthly basis we estimate 155,278
starts.
Stanford University 9
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 3.7
bj 1
t ~ t118
se b j
The results for each company are given in the following table:
For Disney, GE, GM and IBM, we failed to reject the null hypothesis, indicating that the
sample data are consistent with the conjecture that the Disney, GE, GM and IBM stocks
have the same volatility as the market portfolio. For Microsoft and Mobil-Exxon, we
rejected the null hypothesis, and concluded that these two stocks do not have the same
volatility as the market portfolio.
Stanford University 10
ECON102B: Solutions to Problem Set 1 Spring 2009
(b) We set up the hypotheses H 0 : E j t 1 versus H1 : E j 1 . The relevant test statistic, given
H0 is true, is
bj 1
t ~ t118
se b j
The rejection region is t < 1.658 where tc t(0.05,118) 1.658 . The value of the test
statistic is
0.4030 1
t 7.256
0.08228
Since t = 7.256 < tc = 1.658, we reject H0 and conclude that Mobil-Exxon’s beta is less
than 1. A beta equal to 1 suggests a stock's variation is the same as the market variation. A
beta less than 1 implies the stock is less volatile than the market; it is a defensive stock.
(c) We set up the hypotheses H 0 : E j d 1 versus H1 : E j ! 1 . The relevant test statistic, given
H0 is true, is
bj 1
t ~ t118
se b j
The rejection region is t > 1.658 where tc t(0.95,118) 1.658 . The value of the test statistic
is
1.4299 1
t 2.284
0.1882
Since t = 2.284 > tc = 1.658, we reject H0 and conclude that Microsoft’s beta is greater
than 1. A beta equal to 1 suggests a stock's variation is the same as the market variation. A
beta greater than 1 implies the stock is more volatile than the market; it is an aggressive
stock.
(d) A 95% interval estimator for Microsoft’s beta is b j r t(0.975,118) u se(b j ) . Using our sample
of data the corresponding interval estimate is
1.4299 r 1.980 u 0.1882 = (1.057, 1.803)
Thus we estimate, with 95% confidence, that Microsoft’s beta falls in the interval 1.057 to
1.803. It is possible that Microsoft’s beta falls outside this interval, but we would be
surprised if it did, because the procedure we used to create the interval works 95% of the
time. The problem with the interval estimate is that it is wide. We feel sure that Microsoft
is more volatile than the market, but how much more is not known precisely.
Stanford University 11
ECON102B: Solutions to Problem Set 1 Spring 2009
(e) The two hypotheses are H0: D j = 0 versus H1: D j z 0. The test statistic, given H0 is true, is
aj
t ~ t118
se a j
We do not reject the null hypothesis for any of the stocks. This indicates that the sample
data is consistent with the conjecture from economic theory that the intercept term equals
0.
Stanford University 12
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 3.8
(a) We set up the hypotheses H0: E2 = 0 versus H1: E2 < 0. The alternative E2 < 0 is chosen
because an inverse relationship is one where the dependent variable increases as the
independent variable decreases, and visa versa. Thus, a negative E2 suggests an inverse
relationship between variables. The test statistic, given H0 is true, is
b2
t ~ t(182)
se(b2 )
The rejection region is t t(0.05,182) 1.653 . The value of the test statistic is
194.233
t 19.031
10.2061
Since t = 19.03 < 1.653, we reject the null hypothesis that E2 0 and accept the
alternative that E2 0 . We conclude that there is a statistically significant inverse
relationship between the number of house starts and the 30-year fixed interest rate.
(b) We set up the hypotheses H 0 : E2 150 versus H1 : E2 z 150 . The test statistic, given
H0 is true, is
b2 E2
t ~ t(182)
se(b2 )
The rejection region is t 1.973 and t ! 1.973 , with t(0.975,182) 1.973 . The value of the
test statistic is
194.233 150
t 4.334
10.2061
Since t = 4.334 < 1.973, we reject the null hypothesis E2 150 and accept the
alternative that E2 z 150 . The data indicate that, if the 30-year fixed interest rate
increases by 1%, house starts will not fall by 150,000.
(c) A 95% interval estimate of the slope from the regression estimated in part (a) is:
194.233 r 1.973 u 10.2061 (214.4, 174.1)
This interval estimate suggests that, with 95% confidence, an increase in the 30-year fixed
interest rate by 1% will result in a drop in house starts of between 174,100 to 214,400
houses. We would be surprised if the true value of E2 did not lie in this interval.
In part (b) we tested, at a 5% level of significance, whether E2 = 150 , and we came to the
conclusion that E2 z 150 . This conclusion is consistent with our interval estimate
because at a 95% level of confidence, 150 lies outside the interval. Remember the
relationship between confidence intervals and hypothesis testing: At a 1 D level of
confidence and an D level of significance, we will not reject a null hypothesis for a
hypothesized value if it falls inside the confidence interval.
Stanford University 13
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 4.7
(a) ŷ0 b2 x0
11.6044
Ru2 1 0.967
352
y y º¼
2
Vˆ 2yyˆ ª ¦ yˆi yˆ
¬ i (42.549) 2
(c) r 2
0.943
¦ y y ¦ yˆ yˆ
yyˆ
Vˆ Vˆ
2
y
2
yˆ
2 2
65.461 u 29.333
i i
The two alternative goodness of fit measures Ru2 and ryy2ˆ are not equal.
Stanford University 14
ECON102B: Solutions to Problem Set 1 Spring 2009
EXERCISE 4.12
In May 2005: n
STARTS 2992.739 194.2334 u 6.00 1827
In June 2005: n
STARTS 2992.739 194.2334 u 5.82 1862
f n
STARTS0 STARTS 2041 1827 214
0
f n
STARTS0 STARTS 2065 1862 203
0
Stanford University 15