Week 1: Statistics –

Estimation & inference

Dr. Maria Giamouzi
Applied Econometrics A
Outline

• Lesson 1 – Random Sampling

• Lesson 2 – Estimation

• Lesson 3 – Inference

• Lesson 4 – Introduction to R

Dr. Maria Giamouzi

Sample vs.
Population – Notations

SAMPLE POPULATION
mean 𝑥̅ 𝜇
sample size 𝑛 𝑁
variance 𝑠' 𝜎'
Standard deviation 𝑠 𝜎

Dr. Maria Giamouzi

Measure of Central Tendency – MEAN
• The Mean of a set of numerical observations is the sum of the set
divided by the number of observations.

∑.+,- 𝑥+ 𝑥- + 𝑥' + ⋯ + 𝑥.
𝑥̅ = 𝜇 = =
𝑛 𝑛

Where:
n is the total number of observations
1 is the SAMPLE mean
𝒙
𝝁 is the POPULATION mean
Dr. Maria Giamouzi
Exercise 1 - mean
We collected the weight in kilos of 10 postgraduate students from the MSc in Management at
the University of Bath.
Given the data from the table below, estimate the average weight of the sample.
weight in
n
kilos
1 50
2 55
3 60
4 76
5 47
6 58
7 64
8 72
9 80
10 59
Total 621

Dr. Maria Giamouzi

Exercise 1 - mean
We collected the weight in kilos of 10 postgraduate students from the MSc in Management at
the University of Bath.
Given the data from the table below, estimate the average weight of the sample.
weight in
n
kilos
1 50
2 55
3 60
4 76
5 47 Solution:
6 58
7 64 ∑.+,- 𝑥+ 50 + 55 + 60 + 76 + 47 + 58 + 64 + 72 + 80 + 59 621
8 72 𝑥̅ = = = = 𝟔𝟐. 𝟏
9 80 𝑛 10 10
10 59
Total 621

Dr. Maria Giamouzi

Exercise 1 - mean
We collected the weight in kilos of 10 postgraduate students from the MSc in Management at
the University of Bath.
Given the data from the table below, estimate the average weight of the sample.
weight in
n
kilos
1 50
2 55
3 60
4 76
5 47 Solution:
6 58
7 64 ∑.+,- 𝑥+ 50 + 55 + 60 + 76 + 47 + 58 + 64 + 72 + 80 + 59 621
8 72 𝑥̅ = = = = 62.1
9 80 𝑛 10 10
10 59
Total 621 On average the students from the MSc in Management weight 62 kilos.

Dr. Maria Giamouzi

Exercise 2 - mean
• The following sample of twelve marks from a mid-term test was
collected:
36 40 75 65 50 55 35 65 30 45 42 25

Compute the sample’s Mean

Solution:
∑.+,- 𝑥+ 36 + 40 + 75 + 65 + 50 + 55 + 35 + 65 + 30 + 45 + 42 + 25 563
𝑥̅ = = = = 46.92
𝑛 12 12

On average the at the mid-term test the students scored 47%.

Dr. Maria Giamouzi

Measure of Central Tendency – summary

Advantages Disadvantages
Mean • All observations are used in the calculation • Affected by extreme values
• Useful for statistical analysis
• Easy to find for ungrouped data

Dr. Maria Giamouzi

Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08
.06
Density
.04
.02
0

50 60 70 80
var1

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08
.06
Density
.04
.02
0

50 60 70 80
var1

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08
.06
Density
.04
.02
0

50 60 70 80
var1

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08

.05
.04
.06

.03
Density
Density
.04

.02
.02

.01
0
0

50 60 70 80 20 40 60 80 100
var1 var2

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08

.05
.04
.06

.03
Density
Density
.04

.02
.02

.01
0
0

50 60 70 80 20 40 60 80 100
var1 var2

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08

.05
.04
.06

.03
Density
Density
.04

.02
.02

.01
0
0

50 60 70 80 20 40 60 80 100
var1 var2

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
.08

.05
A .04
B Which curve (A or B) do
.06

you believe has the

.03
Density
Density

highest standard
.04

.02

deviation?
.02

.01
0
0

50 60 70 80 20 40 60 80 100
var1 var2

Dr. Maria Giamouzi

Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.

.05
A .04
B Which curve (A or B) do
you believe has the
.03
Density

highest standard
.02

deviation?
.01
0

20 40 60 80 100
. summ var2 var2

Variable Obs Mean Std. Dev. Min Max

var2 80 64.8125 9.26282 30 90 Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.

To calculate the sample variance of a set of

observations:
• Step 1: subtract the mean from each data item;
• Step 2: square each of these;
• Step 3: add up all the squares;
• Step 4: divide by one less than the number of
observations.

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
Value
𝑥- 4
To calculate the sample variance of a set of 𝑥' 0
observations: 𝑥D 8
• Step 1: subtract the mean from each data item;
𝑥E 11
• Step 2: square each of these;
• Step 3: add up all the squares; 𝑥F 12
• Step 4: divide by one less than the number of
observations.

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
Value
𝑥- 4
To calculate the sample variance of a set of 𝑥' 0
observations: 𝑥D 8
• Step 1: subtract the mean from each data item;
𝑥E 11
• Step 2: square each of these;
• Step 3: add up all the squares; 𝑥F 12
.
• Step 4: divide by one less than the number of 35
observations. C 𝑥+
+,-

Dr. Maria Giamouzi

 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
Value
𝑥- 4
To calculate the sample variance of a set of 𝑥' 0
observations: 𝑥D 8
• Step 1: subtract the mean from each data item;
𝑥E 11
• Step 2: square each of these;
• Step 3: add up all the squares; 𝑥F 12
.
• Step 4: divide by one less than the number of 35
observations. C 𝑥+
+,-
∑. 𝑥 35/5 = 7
𝑥̅ = +,- +G𝑛
Dr. Maria Giamouzi
 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
Value Deviation (Step 1)
𝑥- 4 4 − 7 = −3
To calculate the sample variance of a set of 𝑥' 0 0 − 7 = −7
observations: 𝑥D 8 8−7=1
• Step 1: subtract the mean from each data item;
𝑥E 11 11 − 7 = 4
• Step 2: square each of these;
• Step 3: add up all the squares; 𝑥F 12 12 − 7 = 5
.
• Step 4: divide by one less than the number of 35
observations. C 𝑥+
+,-
∑. 𝑥 35/5 = 7
𝑥̅ = +,- +G𝑛
Dr. Maria Giamouzi
 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small.
Value Deviation (Step 1) Squared (Step 2)
'
𝑥- 4 4 − 7 = −3 −3 =9
To calculate the sample variance of a set of 𝑥' 0 0 − 7 = −7 −7 '
= 49
observations: 𝑥D 8 8−7=1 1 '
=1
• Step 1: subtract the mean from each data item; '
𝑥E 11 11 − 7 = 4 4 = 16
• Step 2: square each of these;
'
• Step 3: add up all the squares; 𝑥F 12 12 − 7 = 5 5 = 25
.
• Step 4: divide by one less than the number of 35
observations. C 𝑥+
+,-
∑. 𝑥 35/5 = 7
𝑥̅ = +,- +G𝑛
Dr. Maria Giamouzi
 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small. Step 3: add up all the
squares - ∑.+,- 𝑥+ − 𝑥̅ '

Value Deviation (Step 1) Squared (Step 2)

'
𝑥- 4 4 − 7 = −3 −3 =9
To calculate the sample variance of a set of 𝑥' 0 0 − 7 = −7 −7 '
= 49
observations: 𝑥D 8 8−7=1 1 '
=1
• Step 1: subtract the mean from each data item; '
𝑥E 11 11 − 7 = 4 4 = 16
• Step 2: square each of these;
'
• Step 3: add up all the squares; 𝑥F 12 12 − 7 = 5 5 = 25
.
• Step 4: divide by one less than the number of 35 100
observations. C 𝑥+
+,-
∑. 𝑥 35/5 = 7
𝑥̅ = +,- +G𝑛
Dr. Maria Giamouzi
 Measure of Variability – Variance
The sample variance of a set .of observations is given by:
'
1
𝑠 = C 𝑥+ − 𝑥̅ '
𝑛−1
+,-
If the data spread out far from the 𝑥̅ then 𝑠 ' is large.
If the data pack tightly around 𝑥,̅ then 𝑠 ' is small. Step 3: add up all the
squares - ∑.+,- 𝑥+ − 𝑥̅ '

Value Deviation (Step 1) Squared (Step 2)

'
𝑥- 4 4 − 7 = −3 −3 =9
To calculate the sample variance of a set of 𝑥' 0 0 − 7 = −7 −7 '
= 49
observations: 𝑥D 8 8−7=1 1 '
=1
• Step 1: subtract the mean from each data item; '
𝑥E 11 11 − 7 = 4 4 = 16
• Step 2: square each of these;
'
• Step 3: add up all the squares; 𝑥F 12 12 − 7 = 5 5 = 25
.
• Step 4: divide by one less than the number of 35 100
observations. C 𝑥+
+,-
∑. 𝑥 35/5 = 7 = 100/(5-1) = 25 Step 4: 𝑠 ' = 25
𝑥̅ = +,- +G𝑛
Exercise
• The following sample of twelve marks from a test was collected:
36 40 75 65 50 55 35 65 30 45 42 25

Compute the sample’s:

i. Variance;

Dr. Maria Giamouzi

Exercise
• The following sample of twelve marks from a test was collected:
36 40 75 65 50 55 35 65 30 45 42 25
Deviation Squared Deviations
Value (Step 1) (Step 2)

Compute the sample’s: 𝒙𝟏

𝒙𝟐
36
40
-10.92
-6.92
119.17
47.84
i. Variance; 𝒙𝟑
𝒙𝟒
75
65
28.08
18.08
788.67
327.01
𝒙𝟓 50 3.08 9.51
𝒙𝟔 55 8.08 65.34
𝒔𝟐 = 𝟐𝟑𝟖. 𝟐𝟕 𝒙𝟕 35 -11.92 142.01
𝒙𝟖 65 18.08 327.01
𝒙𝟗 30 -16.92 286.17
𝒙𝟏𝟎 45 -1.92 3.67
𝒙𝟏𝟏 42 -4.92 24.17
𝒙𝟏𝟐 25 -21.92 480.34
𝒏
C 𝒙𝒊
𝒊,𝟏 563 2620.92

2620.92
𝒙
1 46.92 /(12-1)=238.27
Dr. Maria Giamouzi
Measure of Variability – Standard Deviation
A measure of variability found by taking the square root of the variance
𝑠= 𝑠'

𝑠= 𝑠 ' = 25 = 5

Dr. Maria Giamouzi

Exercise
• The following sample of twelve marks from a test was collected:
36 40 75 65 50 55 35 65 30 45 42 25

Compute the sample’s:

i. Standard Deviation;

𝑠= 𝑠 ' = 238.27 = 15.44

Dr. Maria Giamouzi

 Reading List
Wooldridge, J., 2019, Introductory Econometrics: A Modern Approach,7th Ed., Cengage Learning.
pp. 715-721, Section C2 (7 pages)

Stock, J.H. and Watson, M.W., 2019, Introduction to Econometrics, Global Edition, Pearson
Education Limited.
pp. 81-84, Section 2.5 (4 pages)

pp. 104-107, Section 3.1 (4 pages)

Dr. Maria Giamouzi

 Confidence Interval – Means
• Point estimate produced from a sample is almost certainly not equal
to the population mean.
Point estimate: we never observe the exact population parameter we care about.

Therefore, we use terms like “confidence” – we won’t know things for sure, but we’ll be able
to learn quite a bit from unbiased samples.
Point estimate What is the average weight off
ALL postgraduate students at the
𝑠
1 = 𝟔𝟐. 𝟏
𝒙 University of Bath?
𝑥̅ ± 𝑡TU+V+TWX
𝑛
The average weight of the students
from the MSc in Management is
about 62 kilos.
Dr. Maria Giamouzi
Confidence Interval – Means
Sample Mean and
Standard Error
center of interval

𝑠
𝑥̅ ± 𝑡TU+V+TWX
𝑛
Critical T-value (depends
on confidence level)

Dr. Maria Giamouzi

Confidence Interval – Means
Sample Mean and
Standard Error
center of interval

𝑠
𝑥̅ ± 𝑡TU+V+TWX
𝑛
Critical T-value (depends
on confidence level) Margin of Error
Dr. Maria Giamouzi
 𝑡TU+V+TWX

The 𝑡TU+V+TWX values will determine how

confident we want to be.
Confidence Interval 𝟏 − 𝒂

Chance of being Chance of being

wrong W⁄' . wrong W⁄' .
 𝑡TU+V+TWX

The 𝑡TU+V+TWX values will determine how

confident we want to be.
Confidence Interval 𝟏 − 𝒂
If 𝒂 = 𝟏% our confidence interval is 99%.
If 𝒂 = 𝟓% our confidence interval is 95%.
If 𝒂 = 𝟏𝟎% our confidence interval is 90%.

Chance of being Chance of being

wrong W⁄' . wrong W⁄' .

Dr. Maria Giamouzi

100% Dr. Maria Giamouzi
If 𝒂 = 𝟏% our confidence interval is 99%.

99%

100% Dr. Maria Giamouzi

Chance of being Chance of being
wrong W⁄' . wrong W⁄' .

If 𝒂 = 𝟏% our confidence interval is 99%.

99%

100% Dr. Maria Giamouzi

Chance of being Chance of being
wrong W⁄' . wrong W⁄' .

If 𝒂 = 𝟓% our confidence interval is 95%.

95%

100% Dr. Maria Giamouzi

Chance of being Chance of being
wrong W⁄' . wrong W⁄' .

90%

100% Dr. Maria Giamouzi

The accuracy is
defined in terms of
whether or not the As 𝑎 is increasing
confidence interval
contains the true precision is increasing
population
parameter. but accuracy is
The precision refers
to the width of a decreasing.
confidence interval.

90%

95%

99%

100% Dr. Maria Giamouzi

Confidence Intervals
Definition

A confidence interval for the

population mean turns out to
be all the possible values of
the mean between a lower
and an upper limit.
 How to construct an 𝒙% Confidence Interval
for Means:
• Step 1: Define the x% Confidence Interval formula for Means

𝑥%𝐶𝐼 = 𝑥̅ ± 𝑡_,bc 𝑆𝐸 (Eq. 1)

`

• Step 2: Calculate the sample mean and sample standard deviation.

• Step 3: Choose your desired confidence level (i.e. 90%, 95%, 99%).
These are the most commonly used, but you can
choose your confidence level to be any % that you like.
Dr. Maria Giamouzi
How to construct an 𝒙% Confidence Interval
for Means:
• Step 4: Calculate the standard error. You can find the standard error by using the

f f` f`
following formula 𝑆𝐸 = .
= .
= .

Dr. Maria Giamouzi

 How to construct an 𝒙%
Confidence Interval for Means:

• Step 5: Calculate the 𝑡gU+V+TWX value.

𝒕𝒂,𝒅𝒇 is also the confidence coefficient, where 𝑎 is the
𝟐
confidence level and 𝑑𝑓 (𝑑𝑓 = 𝑛 − 1) defined as the
degrees of freedom.

The critical value of 𝑡_,bc is defined based on the level

`
of confidence and degrees of freedom, thus for
𝑎 = 5% and 𝑑𝑓 = 𝑛 − 1 = 156 − 1 = 155
à the t-critical value is 1.960.

Source: Wooldridge, J., 2019, Introductory Econometrics: A Modern Approach,7th Ed., Cengage Learning, p. 786.
 How to construct an 𝒙%
Confidence Interval for Means:

• Step 5: Calculate the 𝑡gU+V+TWX value.

𝒕𝒂,𝒅𝒇 is also the confidence coefficient, where 𝑎 is the
𝟐
confidence level and 𝑑𝑓 (𝑑𝑓 = 𝑛 − 1) defined as the
degrees of freedom.

The critical value of 𝑡_,bc is defined based on the level

`
of confidence and degrees of freedom, thus for
𝒂 = 𝟓% and 𝑑𝑓 = 𝑛 − 1 = 156 − 1 = 155
à the t-critical value is 1.960.

Source: Wooldridge, J., 2019, Introductory Econometrics: A Modern Approach,7th Ed., Cengage Learning, p. 786.
 How to construct an 𝒙%
Confidence Interval for Means:

• Step 5: Calculate the 𝑡gU+V+TWX value.

𝒕𝒂,𝒅𝒇 is also the confidence coefficient, where 𝑎 is the
𝟐
confidence level and 𝑑𝑓 (𝑑𝑓 = 𝑛 − 1) defined as the
degrees of freedom.

The critical value of 𝑡_,bc is defined based on the level

`
of confidence and degrees of freedom, thus for
𝒂 = 𝟓% and 𝒅𝒇 = 𝒏 − 𝟏 = 𝟏𝟓𝟔 − 𝟏 = 𝟏𝟓𝟓
à the t-critical value is 1.960.

Source: Wooldridge, J., 2019, Introductory Econometrics: A Modern Approach,7th Ed., Cengage Learning, p. 786.
 How to construct an 𝒙%
Confidence Interval for Means:

• Step 5: Calculate the 𝑡gU+V+TWX value.

𝒕𝒂,𝒅𝒇 is also the confidence coefficient, where 𝑎 is the
𝟐
confidence level and 𝑑𝑓 (𝑑𝑓 = 𝑛 − 1) defined as the
degrees of freedom.

The critical value of 𝑡_,bc is defined based on the level

`
of confidence and degrees of freedom, thus for
𝒂 = 𝟓% and 𝒅𝒇 = 𝒏 − 𝟏 = 𝟏𝟓𝟔 − 𝟏 = 𝟏𝟓𝟓
à the t-critical value is 1.960.

Source: Wooldridge, J., 2019, Introductory Econometrics: A Modern Approach,7th Ed., Cengage Learning, p. 786.
 Reading List
Wooldridge, J., 2019, Introductory Econometrics: A Modern Approach,7th Ed., Cengage Learning.
pp. 727-733, Section C5 (7 pages)

Stock, J.H. and Watson, M.W., 2019, Introduction to Econometrics, Global Edition, Pearson
Education Limited.
pp. 117-118, Section 3.3 (2 pages)

Dr. Maria Giamouzi

Confidence Intervals (differences)
In the previous slides, we have considered estimating the properties
(expected value and variance) of a single population.

We might also be interested in comparing the properties of two

different populations where, again, the populations are determined by
the question of interest. For example, we might be interested in
whether there is a gender pay gap, i.e. a difference in mean pay
between men and women.

Dr. Maria Giamouzi

Confidence Intervals (differences) - formula

𝑌oq − 𝑌or ± 𝑡TU+V+TWX SE 𝑌oq − 𝑌or

'
𝑠q 𝑠r'
SE 𝑌oq − 𝑌or = +
𝑛q 𝑛r

Dr. Maria Giamouzi

 Reading List

Stock, J.H. and Watson, M.W., 2019, Introduction to Econometrics, Global Edition, Pearson
Education Limited.
pp. 120, Section 3.4 (1 page)

Dr. Maria Giamouzi

Practice Problem: Estimation Exercises –
Exercise 1
Given the sample:

10.3 4.2 -6.1 18.1 7.3 -2.4 0.8 5.4 -1.0 10.7

A. Estimate the mean and variance of the population from which the sample is drawn.

B. Calculate a 99% confidence interval for the mean of the population from which the
sample is drawn.
C. Write a brief description of the calculated confidence interval.

Dr. Maria Giamouzi

 Exercise 1 – Solution A
A. Estimate the mean and variance of the population from which the sample is drawn.

∑.+,- 𝑥+
𝑥̅ =
𝑛

𝑛 =?
𝑥- =?
𝑥' =?

Dr. Maria Giamouzi

 Exercise 1 – Solution A
A. Estimate the mean and variance of the population from which the sample is drawn.

∑.+,- 𝑥+
𝑥̅ =
𝑛

𝑛 = 10
𝑥- = 10.3
𝑥' = 4.2

Dr. Maria Giamouzi

 Exercise 1 – Solution A
A. Estimate the mean and variance of the population from which the sample is drawn.

∑.+,- 𝑥+
𝑥̅ = 𝑥- + 𝑥' + 𝑥D + 𝑥E + 𝑥F + 𝑥v + 𝑥w + 𝑥x + 𝑥y + 𝑥-z
𝑛 𝑥̅ = =
10

𝑛 = 10
𝑥- = 10.3 10.3 + 4.2 + −6.1 + 18.1 + 7.3 + −2.4 + 0.8 + 5.4 + −1.0 + 10.7
𝑥' = 4.2 =
10

1 = 𝟒. 𝟕𝟑
𝒙

Therefore, the mean of the population from which the sample is drawn is equal to 4.73.

Dr. Maria Giamouzi

 Exercise 1 – Solution A
A. Estimate the mean and variance of the population from which the sample is drawn.

𝒏 𝟐
𝟐
∑ 1
𝒊,𝟏 𝒙𝒊 − 𝒙
𝒔 =
𝒏−𝟏

' '
𝑥- − 𝑥̅ + 𝑥' − 𝑥̅ + 𝑥D − 𝑥̅ ' + 𝑥E − 𝑥̅ '
+ ⋯ + 𝑥-z − 𝑥̅ '
𝑠' = =
10 − 1

Dr. Maria Giamouzi

 Exercise 1 – Solution A
A. Estimate the mean and variance of the population from which the sample is drawn.

∑ 𝒏 𝟐
𝟐
1
𝒊,𝟏 𝒙𝒊 − 𝒙
𝒔 =
𝒏−𝟏

𝑥- − 𝑥̅ ' + 𝑥' − 𝑥̅ ' + 𝑥D − 𝑥̅ ' + 𝑥E − 𝑥̅ ' + ⋯ + 𝑥-z − 𝑥̅ '

𝑠' = =
10 − 1

10.3 − 4.73 ' + 4.2 − 4.73 ' + −6.1 − 4.73 ' + 𝑥E − 4.73 ' + ⋯ + 10.7 − 4.73 '
𝑠' = =
10 − 1

𝒔𝟐 = 𝟓𝟐. 𝟏𝟐𝟗

Therefore, the variance of the population from which the sample is drawn is equal to 52.129.
Dr. Maria Giamouzi
B. Calculate a 99% confidence interval for the mean of the population from which the sample is drawn.

Exercise 1 – Solution B
𝑥̅ ± 𝑡bc,W 𝑠. 𝑒. 𝑥̅
'

Dr. Maria Giamouzi

Exercise 1 – Solution B
𝑥̅ ± 𝑡bc,W 𝑠. 𝑒. 𝑥̅
'
1 = 𝟒. 𝟕𝟑
• 𝒙 • 𝒂 = 𝟏%
• 𝒔𝟐 = 𝟓𝟐. 𝟏𝟐𝟗 • 𝒏 = 𝟏𝟎

𝑠 52.129 7.22
𝑠. 𝑒. 𝑥̅ = = = = 2.283
𝑛 10 3.162

𝑡bc,W bc,.|-,y
'
𝑡 -% → 𝑡y,z.zzF = 3.250
y,
'
 Exercise 1 – Solution B
𝑥̅ ± 𝑡bc,W 𝑠. 𝑒. 𝑥̅
'
1 = 𝟒. 𝟕𝟑
• 𝒙 • 𝒂 = 𝟏%
• 𝒔𝟐 = 𝟓𝟐. 𝟏𝟐𝟗 • 𝒏 = 𝟏𝟎

𝑠 52.129 7.22
𝑠. 𝑒. 𝑥̅ = = = = 2.283
𝑛 10 3.162

𝑡bc,W bc,.|-,y
'
𝑡 -% → 𝑡y,z.zzF = 3.250
y,
'

99% 𝐶𝐼 → 𝑥̅ ± 𝑡bc,W 𝑠. 𝑒. 𝑥̅ = 4.73 ± 3.250(2.283)

'

4.73 ± 7.42 = 4.73 − 7.42; 4.73 + 7.42

𝟗𝟗% 𝑪𝑰 = −𝟐. 𝟔𝟗; 𝟏𝟐. 𝟏𝟓
lower upper
bound bound
 Exercise 1 – Solution B
𝑥̅ ± 𝑡bc,W 𝑠. 𝑒. 𝑥̅
'
1 = 𝟒. 𝟕𝟑
• 𝒙 • 𝒂 = 𝟓%
• 𝒔𝟐 = 𝟓𝟐. 𝟏𝟐𝟗 • 𝒏 = 𝟏𝟎

𝑠 52.129 7.22
𝑠. 𝑒. 𝑥̅ = = = = 2.283
𝑛 10 3.162

𝑡bc,W bc,.|-,y
'
𝑡 F% → 𝑡y,z.z'F = 2.262
y,
'

95% 𝐶𝐼 → 𝑥̅ ± 𝑡bc,W 𝑠. 𝑒. 𝑥̅ = 4.73 ± 2.262(2.283)

'

4.73 ± 5.165 = 4.73 − 5.165; 4.73 + 5.165

𝟗𝟓% 𝑪𝑰 = −𝟎. 𝟒𝟑𝟓; 𝟗. 𝟖𝟗𝟓
lower upper
bound bound
 C. Write a brief description of the calculated confidence interval.

Exercise 1 – Solution C
𝟗𝟗% 𝑪𝑰 = −𝟐. 𝟔𝟗; 𝟏𝟐. 𝟏𝟓
Therefore, we are 99% confident that the population mean lies within the range
− 2.69 to 12.15.
The majority of this range is positive, but we cannot rule out the possibility of a
negative value for the population mean.
We are not certain that the population mean lies within this interval because it is
possible that our sample is amongst the 1% of samples.

Dr. Maria Giamouzi

 C. Write a brief description of the calculated confidence interval.

Exercise 1 – Solution C
𝟗𝟗% 𝑪𝑰 = −𝟐. 𝟔𝟗; 𝟏𝟐. 𝟏𝟓
𝟗𝟓% 𝑪𝑰 = −𝟎. 𝟒𝟑𝟓; 𝟗. 𝟖𝟗𝟓

−𝟐. 𝟔𝟗 −𝟎. 𝟒𝟑𝟓 𝟗. 𝟖𝟗𝟓 𝟏𝟐. 𝟏𝟓

𝟗𝟗% 𝑪𝑰

𝟗𝟓% 𝑪𝑰

Precision Accuracy
Precision vs Accuracy 95% CI high low
99% CI low high
Dr. Maria Giamouzi
 Practice Problem: Estimation Exercises –
Exercise 2
Suppose that a sample of 20 AAA-rated corporate bonds has a mean return of 1.03% and variance
of 9, whereas a sample of the common stock of the same companies has a mean return
of 1.85% and variance of 25. Suppose also that the covariance of returns between the two samples
is −5.

A. Calculate a 90% confidence interval for the difference in population mean between stocks and bonds.

For the purposes of the question, suppose that the different bonds all have the same distribution and that the different
stocks all have the same distribution. This is arguably not very realistic but serves our purposes here.

B. Given the results, which of the asset classes would you prefer to invest in?

Dr. Maria Giamouzi

Exercise 2 – Solution A
Basic Finance Theory suggests that investors should aim to maximize their
(expected) return while minimizing their risk.
The ideal asset would then be one which had the highest population mean and
lowest population variance, among all possible investments.
In practice, we tend to observe that safer assets (those with less variable returns)
have lower returns and vice versa. In this question the bonds are estimated to have
lower population mean and population variance than the stocks.
à Before making any investment decision we should first consider whether the
difference in returns is just an artifact of the samples.

Dr. Maria Giamouzi

 A. Calculate a 90% confidence interval for the difference in population mean between stocks and bonds.

Exercise 2 – Solution A
90% CI → 𝑌oq − 𝑌or ± 𝑡TU+V+TWX SE 𝑌oq − 𝑌or
• 𝑌oq − 𝑌or → 𝑆̅ − 𝐵o = 1.85 − 1.03 = 0.82
`
f‚ `
fƒ f„` `
f… y 'F F
• SE 𝑌oq − 𝑌or = + → SE 𝑆̅ − 𝐵o = + = 𝑉𝑎𝑟 𝑆̅ + 𝑉𝑎𝑟 𝐵o − 2𝐶𝑜𝑣 𝑆,̅ 𝐵o = + −2 − = 2.2
.‚ .ƒ .„ .… 'z 'z 'z

• 𝑡TU+V+TWX → 𝑡bc,_ → 𝑡-y,z.zF = 1.729

`

Dr. Maria Giamouzi

 Exercise 2 – Solution A
90% CI → 𝑌oq − 𝑌or ± 𝑡TU+V+TWX SE 𝑌oq − 𝑌or
• 𝑌oq − 𝑌or → 𝑆̅ − 𝐵o = 1.85 − 1.03 = 0.82
`
f‚ `
fƒ f„` `
f… y 'F F
• SE 𝑌oq − 𝑌or = + → SE 𝑆̅ − 𝐵o = + = 𝑉𝑎𝑟 𝑆̅ + 𝑉𝑎𝑟 𝐵o − 2𝐶𝑜𝑣 𝑆,̅ 𝐵o = + −2 − = 2.2
.‚ .ƒ .„ .… 'z 'z 'z

• 𝑡TU+V+TWX → 𝑡bc,_ → 𝑡-y,z.zF = 1.729

`

Then, the 90% confidence interval is equal to:

𝟗𝟎%𝑪𝑰 → 𝑆̅ − 𝐵o ± 𝑡bc,W 𝑆𝐸 𝑆̅ − 𝐵o
'
= 0.82 ± 𝑡-y,z.zF 2.2
= 0.82 ± 1.729 1.483 = −𝟏. 𝟕𝟓; 𝟑. 𝟑𝟗

Dr. Maria Giamouzi

 Exercise 2 – Solution A
90% CI → 𝑌oq − 𝑌or ± 𝑡TU+V+TWX SE 𝑌oq − 𝑌or
• 𝑌oq − 𝑌or → 𝑆̅ − 𝐵o = 1.85 − 1.03 = 0.82
`
f‚ `
fƒ f„` `
f… y 'F F
• SE 𝑌oq − 𝑌or = + → SE 𝑆̅ − 𝐵o = + = 𝑉𝑎𝑟 𝑆̅ + 𝑉𝑎𝑟 𝐵o − 2𝐶𝑜𝑣 𝑆,̅ 𝐵o = + −2 − = 2.2
.‚ .ƒ .„ .… 'z 'z 'z

• 𝑡TU+V+TWX → 𝑡bc,_ → 𝑡-y,z.zF = 1.729

`

Then, the 90% confidence interval is equal to:

𝟗𝟎%𝑪𝑰 → 𝑆̅ − 𝐵o ± 𝑡bc,W 𝑆𝐸 𝑆̅ − 𝐵o
'
= 0.82 ± 𝑡-y,z.zF 2.2
= 0.82 ± 1.729 1.483 = −𝟏. 𝟕𝟓; 𝟑. 𝟑𝟗

Hence, we are 90% confident that the true population mean

difference lies between -1.75 and 3.39. That can also be expressed
mathematically as follows: −1.75 ≤ 𝜇‹ − 𝜇Œ ≤ 3.39
 Exercise 2 – Solution A
We have found that the confidence interval for the
difference between the population expected return
on stocks and the population expected return on
bonds includes negative values (as well as relatively
large positive values).
Thus it is possible that stocks do offer a better return
than bonds, but it is also possible that they do not. It
could be argued that the evidence in this case does
not provide strong reasons to prefer one asset class
over the other.