Introduction

to Econometrics (4th Edition)

by


James H. Stock and Mark W. Watson





Solutions to End-of-Chapter Exercises: Chapter 5*


(This version September 14, 2018)











*Limited distribution: For Instructors Only. Answers to all odd-numbered
questions are provided to students on the textbook website. If you find errors in
the solutions, please pass them along to us at mwatson@princeton.edu.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 1
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5.1 (a) The 95% confidence interval for b1 is {-5.82 ± 1.96 ´ 2.21}, that is

-10.152 £ b1 £ -1.4884.

(b) Calculate the t-statistic:

bˆ 1 - 0 -5.82
t act = = = -2.6335.
SE( bˆ 1) 2.21

The p-value for the test H 0 : b1 = 0 vs. H1 : b1 ¹ 0 is

p-value = 2F(-|t act |) = 2F (-2.6335) = 2 ´ 0.0042 = 0.0084.

The p-value is less than 0.01, so we can reject the null hypothesis at the 5%
significance level, and also at the 1% significance level.

(c) The t-statistic is

bˆ 1 - (-5.6) 0.22
t act = = = 0.10
SE ( bˆ 1) 2.21

The p-value for the test H 0 : b1 = -5.6 vs. H1 : b1 ¹ -5.6 is

p-value = 2F (-|t act |) = 2F (-0.10) = 0.92

The p-value is larger than 0.10, so we cannot reject the null hypothesis at the
10%, 5% or 1% significance level. Because b1 = -5.6 is not rejected at the 5%

level, this value is contained in the 95% confidence interval.

(d) The 99% confidence interval for b0 is {520.4 ± 2.58 ´ 20.4}, that is,

467.7 £ b0 £ 573.0.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 2
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5.2. (a) The estimated gender gap equals $2.12/hour.

(b) The hypothesis testing for the gender gap is H 0 : b1 = 0 vs. H1 : b1 ¹ 0. With a t-

bˆ 1 - 0 2.12
statistic t act = = = 5.89, the p-value for the test is
SE ( bˆ 1) 0.36

p-value = 2Φ(−|t act |) = 2Φ (−5.89) = 2 × 0.0000 = 0.000 (to four decimal places).
The p-value is less than 0.01, so we can reject the null hypothesis that there is no
gender gap at a 1% significance level.

(c) The 95% confidence interval for the gender gap b1 is {2.12 ± 1.96 ´ 0.36}, that

is, 1.41 £ b1 £ 2.83.

(d) The sample average wage of women is bˆ0 = $12.52/hour. The sample average

wage of men is bˆ 0 + bˆ 1 = $12.52 + $2.12 = $14.64/hour.

(e) The binary variable regression model relating wages to gender can be written as
either Wage = b0 + b1Male + ui , or Wage = g 0 + g 1Female + vi . In the first

regression equation, Male equals 1 for men and 0 for women; b 0 is the

population mean of wages for women and b0 + b1 is the population mean of

wages for men. In the second regression equation, Female equals 1 for women
and 0 for men; g 0 is the population mean of wages for men and g 0 + g 1 is the
population mean of wages for women. We have the following relationship for the
coefficients in the two regression equations:

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 3
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5.2 (continued)

g 0 = b 0 + b1 ,
g 0 + g 1 = b0 .

Given the coefficient estimates b̂ 0 and bˆ 1 , we have

gˆ 0 = bˆ 0 + bˆ 1 = 14.64,
gˆ1 = bˆ 0 - gˆ 0 = -bˆ 1 = -2.12.

Due to the relationship among coefficient estimates, for each individual

observation, the OLS residual is the same under the two regression equations:

uˆ i = vˆi. Thus the sum of squared residuals, SSR = å i =1 uˆ i , is the same under the
2 n

two regressions. This implies that both SER = ( SSR

n -1 )
1
2
and R 2 = 1 - TSS
SSR
are

unchanged.

In summary, in regressing Wages on Female, we will get

! = 14.64 − 2.12Female,
Wages R2 = 0.06, SER = 4.2.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 4
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5.3. The 99% confidence interval is 1.5 ´ {3.94 ± 2.58 ´ 0.31) or

4.71 lbs £ WeightGain £ 7.11 lbs.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 5
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5.4. (a) -12.12 + 2.37 ´ 16 = $25.80 per hour

(b) The wage is expected to increase by 2.37×2 = $4.74 per hour.

(c) The increase in wages for college education is b1 ´ 4. Thus, the counselor’s
assertion is that b1 = 10/4 = 2.50. The t-statistic for this null hypothesis is

t= 2.37−2.50
0.10
= −1.3, which has a p-value of 0.19 Thus, the counselor’s assertion

cannot be rejected at the 10% significance level. A 95% confidence for b1 ´ 4 is

4 ´ (2.37 ± 1.96 ´ 0.10) or $8.70 £ Gain £ $10.36.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 6
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5. 5 (a) The estimated gain from being in a small class is 13.9 points. This is equal to
approximately 1/5 of the standard deviation in test scores, a moderate increase.

(b) The t-statistic is t act = 13.9

2.5 = 5.56,
which has a p-value of 0.00. Thus the null
hypothesis is rejected at the 5% (and 1%) level.

(c) 13.9 ± 2.58 ´ 2.5 = 13.9 ± 6.45.

(d) Yes. Students were randomly assigned to small or regular classes, so that SmallClass is
independent of characteristics of the student, including those affecting testscores, that is
u. Thus E(ui | ClassSizei) = 0.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 7
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5.6. (a) The question asks whether the variability in test scores in large classes is the
same as the variability in small classes. It is hard to say. On the one hand, teachers in
small classes might able so spend more time bringing all of the students along, reducing
the poor performance of particularly unprepared students. On the other hand, most of
the variability in test scores might be beyond the control of the teacher.

(b) The formula in 5.3 is valid for heteroskesdasticity or homoskedasticity; thus

inferences are valid in either case.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 8
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5.7. (a) The t-statistic is 3.2

1.5 = 2.13 with a p-value of 0.03; since the p-value is less than
0.05, the null hypothesis is rejected at the 5% level.

(b) 3.2 ± 1.96 ´ 1.5 = 3.2 ± 2.94

(c) Yes. If Y and X are independent, then b1 = 0; but the p-value in (a) was 0.03. This
means that only in 3% of all samples, the absolute value of t-statistic would be
2.13 (the value actually observed in this sample) or larger.

(d) b1 would be rejected at the 5% level in 5% of the samples; 95% of the

confidence intervals would contain the value b1 = 0.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 9
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5.8. (a) 43.2 ± 2.05 ´ 10.2 or 43.2 ± 20.91, where 2.05 is the 5% two-sided critical value
from the t28 distribution.

(b) The t-statistic is t act = 61.5-55

7.4 = 0.88, which is less (in absolute value) than the
critical value of 2.05. Thus, the null hypothesis is not rejected at the 5% level.

(c) The one sided 5% critical value is 1.70; tact is less than this critical value, so that
the null hypothesis is not rejected at the 5% level.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 10
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1
(Y1 + Y2 +!+ Yn )
5.9. (a) β = n
so that it is linear function of Y1, Y2, …, Yn.
X

(b) E(Yi|X1, …, Xn) = b1Xi, thus

1 1
E( β |X 1 ,…, X n ) = E (Y + Y +!+ Yn )|X 1 ,…, X n )
X n 1 2
1 1
= β ( X +!+ X n ) = β1
X n 1 1

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 11
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5.10. Let n0 denote the number of observation with X = 0 and n1 denote the number of
å å
n n
X = n1; X = n1| n; n11 i =1 X iYi = Y1;
i =1 i
observations with X = 1; note that

å
n
( )
( X i - X ) 2 =å i =1 X i2 - nX 2 = n1 - nn1 = n1 1 - nn1 =
n
; n1Y1 + n0Y0 = å i =1Yi ,
n
2
n1n0
i =1 n
so
Y = nn1 Y1 + nn0 Y0
that

From the least squares formula

∑ i=1
n
( X i − X )(Yi − Y ) ∑ i=1
n
X i (Yi − Y ) ∑ i=1
n
X iYi − Yn1
β̂1 = = =
∑ i=1 ( X i − X )
n 2
∑ i=1 ( X i − X )
n 2
n1n0 |n
n n⎛ n n ⎞
= (Y1 − Y ) = ⎜ Y − 1 Y1 − 0 Y0 ⎟ = Y1 − Y0 ,
n0 n0 ⎝ n n ⎠

æn n ö n n +n0
and bˆ0 = Y - bˆ1 X = ç 0 Y0 + 1 Y1 ÷ - (Y1 - Y0 ) 1 = 1 Y0 = Y0
èn n ø n n

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 12
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5.11. Using the results from 5.10, bˆ0 = Ym and bˆ1 = Yw - Ym . From Chapter 3,
bˆ0 = 523.1
s2 s2
SE (Ym ) = Snm SE (Yw - Ym ) = nmm + nww .
m
and Plugging in the numbers and
ˆ ˆ
SE (b0 ) = 6.22; b1 = -38.0 ˆ
SE (b1 ) = 7.65.
and

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 13
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5.12. Equation (4.20) gives

var (H i ui ) µX
s b2ˆ = , where H i = 1 - Xi.
n éë E ( H i2 )ùû E ( X i2 )
0
2

Using the facts that E (ui | X i ) = 0 and var (ui | X i ) = s u2 (homoskedasticity), we have

æ ö
ç µx ÷ µx
E ( H i ui ) = E u -ç
X u = E (ui ) -
÷
E [ X i E (ui | X i )]
E(X ) E ( X i2 )
ç i 2 i i÷
çç i ÷÷
è ø

=0-
µx ´ 0 = 0,
E ( X i2 )

and

ìæ ö 2 üï
ïç
ïï ç µX ÷
÷ ïï
E [( H i ui ) 2 ] = E u -
íç i Xu i i ÷ ýï
ïç
ï çè E æçè X i2 ö÷ø ÷÷
îï ø ïþï

ì 2 ü
ï
µX é µ ù ï
ïï 2 ï
=E u -2 í i X i ui2 + ê æ X 2 ö ú X i2ui2 ïý
ï
ï E æçè X i2 ö÷ø êë E çè X i ÷ø úû ï
ï
îï þï
2
µ é ù
é µ ù é 2 æ 2 öù
= E u - 2 æ X 2 ö E ê X i E èæç ui2| X i øö÷ ú + ê
æ 2ö
çç i ÷÷
X
ú E ê X i E çè ui | X i ÷ø ú
êë æ 2ö úû êë úû
è ø
E çè X i ÷
ø
êë E çè X i ÷ø úû
2
µ é µ ù æ 2ö
= s u2 - 2 æ X 2 ö µ s u2 + ê X
ú E çç X i ÷÷s u2
X
æ 2ö
E çè X i ÷
ø
êë E çè X i ÷ø úû è ø

æ µ2 ö
= ç1 - æ X 2 ö ÷s u2 .
ç E ç Xi ÷ ÷
è è øø

Because E ( H i ui ) = 0, var ( H i ui ) = E[( H i ui ) 2 ], so

æ µ X2 ö 2
var (H i ui ) = E[( H i ui ) ] = ç1 - ÷s . 2
ç E ( X i2 ) ÷ u
è ø

Also (continued next page)

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 14
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5.12 (continued)

ìæ ö 2 üï ì 2 ü
ïç
µX ï
µX é µ ù ï
E ( H i2 ) = E 1 -
÷
ïï ç ÷ ïï ïï 2 ïï
X = E 1- 2 X + ê X
ú X
E ( X i2 ) E ( X i2 ) êë E ( X i ) úû
íç i ÷ ýï í i i ýï
ïç ï 2
÷÷
ï çè ø ïïþ ï ï
îï îï þï
2
µ X2 + é µ X ù E X 2 = 1- µ X2 .
=1- 2 2
ê 2
ú
E ( Xi
i
) êë E ( X i ) úû
2 ( ) E ( Xi )
Thus

æ µX2 ö 2
ç1 - ÷s
var (H i ui ) ç E ( X i2 ) ÷ u s u2
s b2ˆ = = è ø =
0
é nE ( H 2 )2 ù æ ö
2
æ µX2 ö
ûú nç1 - µ X 2 ÷
2
ëê i
n ç1 - ÷
ç E ( Xi ) ÷ ç E ( X i2 ) ÷
è ø è ø
E ( X i2 )s u2 E ( X i2 ) s u2
= = .
n[ E ( X i2 - µ X2 )] ns X2

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 15
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5.13. (a) Yes, this follows from the assumptions in KC 4.3.

(b) Yes, this follows from the assumptions in KC 4.3 and conditional
homoskedasticity

(c) They would be unchanged for the reasons specified in the answers to those
questions.

(d) (a) is unchanged; (b) is no longer true as the errors are not conditionally
homoskesdastic.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 16
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5.14. (a) From Exercise (4.11), bˆ = å aiYi where ai =

Xi
. Since the weights depend
å j=1 X 2j
n

Xi Yi b̂
only on but not on , is a linear function of Y.

∑ i=1
n
X i E(ui |X 1 ,…, X n )
(b) E( β̂ |X 1 ,…, X n ) = β + = β since E(ui |X 1 ,…, X n ) = 0
∑ i=1
n
X 2j

∑ i=1
n
X i 2Var (ui |X 1 ,…, X n ) σ2
(c) Var ( β̂ |X 1 ,…, X n ) = = n 2
⎡ ∑ i=1
n
X 2j ⎤⎦
2
∑ i=1 X j
⎣

(d) This follows the proof in the appendix.

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 Stock/Watson - Introduction to Econometrics 4th Edition - Answers to Exercises: Chapter 5 17
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5.15. Because the samples are independent, bˆm ,1 and bˆw,1 are independent. Thus
var ( bˆm,1 - bˆw,1 ) = var ( bˆm,1 ) + var( bˆw,1 ). Var ( bˆm,1 )
is consistently estimated as
[ SE ( bˆm,1 )]2
Var (bˆw,1 ) [ SE ( bˆw,1 )]2 ,
and is consistently estimated as so that
var( bˆm,1 - bˆw,1 ) [ SE ( bˆm,1 )] + [ SE ( bˆw,1 )]2 ,
2

is consistently estimated by and the result

follows by noting the SE is the square root of the estimated variance.

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