Question One

i. Explain the key assumption and procedures of the Durbin-Watson test and B-G
tests
ii. What are the key differences of the two tests
iii. As an expert in econometrics, what would do when you find the D-W statistics is
significant?
iv. Explain the ordinary least squares (OLS) method. What do you understand by
the statement that OLS estimators are “BLUE”
v. Explain the type of criteria you would employ to evaluate the regression results
vi. Explain what do you understand by a statistical test of an hypothesis. With
specific example discuss how you would carry out a test of parameter significance

Question Two
Consider the following estimated equation

𝑠𝑎ˆ𝑡 = (1,028.10) + (19.30ℎ𝑠𝑖𝑧𝑒 − (2.19ℎ𝑠𝑖𝑧𝑒 7 − (45.09𝑓𝑒𝑚𝑎𝑙𝑒 − (169.81𝑏𝑙𝑎𝑐𝑘

+ (62.31𝑓𝑒𝑚𝑎𝑙𝑒 ∗ 𝑏𝑙𝑎𝑐𝑘
& 0 (6.29)#1 (3.83) &(0.53)ℎ𝑠𝑖𝑧𝑒2 &5(4.29)(12.71) (18.15)

𝑛 = 4,137, 𝑅7 = .0858.
The variable sat is the combined SAT score, hsize is size of the student’s high school
graduating class, in hundreds, female is a gender dummy variable, and black is a race
dummy variable equal to one for blacks, and zero otherwise.

(i) Is there strong evidence that hsize2 should be included in the model? From
this equation, what is the optimal high school size?
(ii) Holding hsize fixed, what is the estimated difference in SAT score between
nonblack females and nonblack males? How statistically significant is this
estimated difference?
(iii) What is the estimated difference in SAT score between nonblack males and
black males? Test the null hypothesis that there is no difference between their
scores, against the alternative that there is a difference.
(iv) What is the estimated difference in SAT score between black females and
nonblack females? What would you need to do to test whether the difference
is statistically significant?

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 Question Three

(a) Explain intuitively why weighted least squares yield more efficient parameter
estimators than ordinary least squares when the error term is known to be
Heteroscedastic
(b) You are estimating the relationship between firms’ sales and advertising
expenditures in an industry. It becomes apparent to you and that half the firms
in the industry are large relative to the other half, and you are concerned about
the proper estimation technique in such a situation. Assume that the error
variances associated with the large firms are twice the error variances associated
with the small firms.
(i) If you used ordinary least squares to estimate the regression of sales
on advertising (assuming that advertising is an independent
variable, uncorrelated with the error term), would your estimated
parameters be unbiased? Consistent? Efficient?
(ii) How might you revise the estimation procedure to eliminate or to
resolve your difficulties?
(iii) Can you test whether the original error variance assumption is
valid?

Question Four

(a) What is the nature of autocorrelation?

(b) What are the theoretical and practical consequences of autocorrelation?
(c) Since the assumption of no autocorrelation relates to the unobservable
disturbances 𝜇 how does one know that there is autocorrelation in any given
situation?
(d) How does one remedy the problem of Heteroscedasticity?

Question Five

Consider the following linear regression model:

𝒚𝒊 = 𝜷𝟏 + 𝜷𝟐 𝒙𝒊𝟐 + 𝜷𝟑 𝒙𝒊𝟑 + 𝝐𝒊

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 a) Explain how the ordinary least squares estimator for 𝛽 is determined and drive
an expression for b.
b) Which assumptions are needed to make b an unbiased estimator for 𝛽?
c) Explain how one can test the hypothesis that 𝛽Q = 1
d) Explain how one can test the hypothesis that 𝛽7 + 𝛽Q = 0
e) Suppose that 𝑥S7 = 𝑥SQ + 𝑢S, where 𝑢S, and 𝑥SQ are uncorrelated. Suppose that the
model is estimated with 𝑢S, included rather then 𝑥S7 . How are the coefficients in
this model related to those in the original model? And the 𝑅7 s?

Question Six

Using sample of 545 full time workers in Tanzania, a researcher is interested in the
question as to whether women are systematically underpaid compared with men. First
she estimates the average hourly wages in the sample for men and women, which are
Tshs 5910 and Tshs 5090 respectively.

a) Do these numbers give an answer to the question of interest? Why or why not?
How could one (at least partially) correct for this if there is a need of doing that.

The same researcher also runs a simple regression of an individual’s wage on a male
dummy, equal to 1 for males and 0 for females. This gives the results reported in the
Table below

Table 1: Hourly wages explained from gender: OLS results

Variable Estimate Standard Error t-ration

Constant 5.09 0.58 8.78

Male 0.82 0.15 5.47

N = 545 s = 2.17 𝑅7 = 0.26

b) How can you interpret the coefficient estimate of 0.82? How do you interpret the
estimated intercept of 5.09?
c) How do you interpret the 𝑅7 of 0.26?
d) Explain the relationship between the coefficient estimates in the Table and the
average wage rates of males and females.

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 e) Having looked at the table and the model you are unhappy with this formulation
of the model as ‘a female dummy is omitted from the model’. Comment upon this
criticism.
f) Test using the above results, the hypothesis that men and women have, on
average the assumptions required for this test to be valid.

Question Seven

Subsequently, the above ‘model’ is extended to include differences in age and education
by including the variable age (age in years) and educ (education level, from 1 to 5).
Simultaneously, the endogenous variable is adjusted to be the natural logarithm of the
hour wage rate. The results are reported in Table 2.

Table 2: Log hourly wages explained from gender, age, education level: OLS results

Variable Estimated Standard error t-ratio

Constant -1.09 0.38 2.88

Male 0.13 0.03 4.47

Age 0.09 0.02 4.38

Educ 0.18 0.05 3.66

N = 545 s = 0.24 𝑅7 = 0.691 𝑅U7 = 0.682

a) How do you interpret the coefficients of 0.13 for the male dummy and 0.09 far
age?
b) Test the joint hypothesis that gender, age, and education do not affect a person’s
wage
c) Again a cruise student, looked at Table 2 results and quite unhappy with this
new model as the ‘effect of education is rather restrictive’. Can you explain to
this student’s criticism? How would the model be extended or changed to meet
the above criticism leveled against it? How can you test whether the extension
has been useful?
d) This researcher re-estimates the above model including age2 as an additional
regressor. The t-value on this new variable becomes -1.14, while 𝑅7 = 0.699 and
𝑅U7 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑠 𝑡𝑜 0.683.

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 I. Would you give a reason why the inclusion of age2 might be appropriate?
II. Would you retain this new variable given the 𝑅7 and 𝑅U7 measures? Would
you retain age2 given its t-value? Explain this apparent conflict in
conclusions.