Econometrics I - Exam 1

Bruno Ferman
March 28th, 2018

Question 1:
Consider the model Yij = β0 +β1 Xj +νj +ij , where Yij is the outcome of student i in school j. Xj is a school-
level covariate, νj is a school-level error, and ij is an individual-level error. Assume that νj |Xj ∼ N (0, σν2 ),
ij |Xj ∼ N (0, σ2 ), cov(ij , νj |Xj ) = 0, and cov(ij , i0 j |Xj ) = 0 for i 6= i0 . You have an i.i.d. sample of G
schools, where for each school you have information on M students (that is, {Y1j , ..., YM j , Xj }G j=1 ).

a. (10 points) Show that the OLS estimator for β1 using all G × M observations (β̂1 ) is numerically equivalent
to the OLS estimator of Ȳj on Xj using G observations (the G schools), where Ȳj is the average outcome in
school j.
b. (10 points) What is the (finite-sample) distribution of β̂1 |X, where X = (X1 , ..., XG )?
c. (10 points) Suppose you run OLS using all G × M observations in Stata. What would happen if you test the
null β1 = 0 (assuming you use the default options of the “reg” command)? How would your answer depend
on σν2 ?
d. (10 points) Suppose G = 5 and M = 1000. How could you test the null hypothesis that β1 = 0?

Question 2:
Consider the model Yi = β1 Xi + ui , where E[ui |Xi ] = 0, E[u2i |Xi ] = σ 2 , and Xi and ui have nonzero finite
fourth moments. Assume further you have an i.i.d. sample {Yi , Xi }N
i=1 .

a. (15 points) Derive the OLS estimator if you regress Yi on Xi (without a constant). Show that this estimator
is consistent and derive its asymptotic distribution. Use the homoskedasticity assumption to simplify the
formulas.

b. (10 points) Show that the estimator derived in item (a) has a lower asymptotic variance relative to the bivariate
OLS estimator of β1 (that is, when you estimate both the intercept and the slope) if E[Xi ] 6= 0.

Question 3:
Let X be a discrete random variable that takes values −1, 0, or 1, each with probability 31 , and Y be a random
variable such that

0, if X = −1

E[Y |X] = 10, if X = 0

0, if X = 1


a. (15 points) What is the OLS population slope? Let u be the OLS population error. Is E[u|X] = 0?

b. (10 points) You have a sample of 3 observations {Xi , Yi }3i=1 , where X1 = −1, X2 = 0, and X3 = 1. Is the
OLS estimator, conditional on these covariate values, unbiased for the OLS population slope?
c. (10 points) Do your answers in items (a) and (b) contradict the results seen in class on the conditions under
which the OLS estimator is unbiased? Why?