Introduction to Econometrics

Project Title:

Abstract
The UAE economy is/was highly dependent on oil and gas. The current
research project analyzes the effects of oil prices on some economic
variables of the UAE. We find out that there is a positive relationship
between oil prices, GDP, GDP per capita. In addition, we see the positive
effect of oil prices on Inflation rates. An important conclusion is that, the
UAE should decrease its dependence on oil production to other sectors.

Introduction
1
Since the creation of the United Arab Emirates (UAE) the country’s
economy was hugely relying on the revenues gained from oil production. Oil
was first discovered in the 1950s. At the beginning of the 1960s, the first oil
company teams carried out preliminary surveys and the first cargo of crude
was exported from Abu Dhabi in 1962. Today, Emirates oil reserves are
ranked as the seventh-largest in the world. 1 The UAE leaders productively
used the oil revenues for building and developing of infrastructural projects.
The country’s current development is due to its oil richness.

The unique role of oil revenues in the structure of government budgets and
social security programs distinguishes the UAE economy from others.
Moreover, Abu Dhabi annually uses the proceeds from its oil sales to
provide between 60 percent to 90 percent of the UAE's federal budget.2

The rise increase/decrease in the price of oil could affect the economy
through petroleum products, energy bills, unit costs and investment.

The change in price of oil has direct and positive effect on the prices of
petroleum products. An increase in the price of oil increases the price of
petroleum products. Decrease in the price of oil decreases the price of
petroleum products. The same principles applies to the energy bill prices.

Moreover, if the price of oil increases the per unit cost of products will
increase. This causes a shift of the demand curve to the left. This means that
if the price of oil products increases the demand for those products will
decrease. The decrease in the demand could cause unemployment. Because
it could be difficult for companies to continue operation.

1
http://en.wikipedia.org/wiki/United_Arab_Emirates
2
http://www.nationsencyclopedia.com/economies/Asia-and-the-Pacific/United-Arab-Emirates-POLITICS-
GOVERNMENT-AND-TAXATION.html

2
The above mentioned points could be reflected in the UAE market. But in
case of government revenues the UAE government might see increase in its
revenues.

Section 1 of this research project will explore the literature on the effect of
oil prices on economic variables (particularly to the UAE). Section 2 will
explore the data and methodology. Section 3 will explain our hypotheses
and findings. Section 4 will conclude.

Main Hypothesis:
The main null hypothesis which we are trying to see and explore is as
follow:

There is a positive relationship between oil prices and GDP, GDP Per
Capita and Inflation in the UAE.

We will examine this relationship using the data of variables of interest. The
data for the above economic variables are described in the following section.

Data and Methodology:

To explore our hypothesis we will need the following data:

Oil prices: our dependent variable is oil price. The importance of this
variable has been elaborated in detail in the introduction, above. We
collected the data for oil prices from International Financial Statistics (IFS)
datasets. The covered years are 1970-2013.

3
Inflation: Inflation is described as the rise in the prices of goods and
services in the economy over a period of time. In general, inflation is an
increase in prices and fall in the purchasing value of money in an economy.
Our data for inflation rate comes from the Mundi datasets. It covers the
years between 1980-2010.

GDP & GDP Per Capita: Gross Domestic Product (GDP) is one of the
hottest topics of our time. Currently each country is trying to increase its
GDP as much as possible. Economists believe that the best measure of
economic wellbeing in a country is its amount of GDP (Mankiw, 2004).
GDP per capital is the taken as GDP divided by total number people in a
country. We got the data for GDP from IMF, World Economic Outlook. It
covers the years between 1980-2014.

Oil prices during 1980-2010

Y
100

90

80

70

60

50

40

30

20

10
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Histogram and Stats of Oil prices

4
14
Series: Y
12 Sample 1980 2010
Observations 31
10
Mean 30.32258
Median 23.00000
8 Maximum 93.00000
Minimum 12.00000
6 Std. Dev. 20.95612
Skewness 1.561212
4 Kurtosis 4.510372

Jarque-Bera 15.53972
2
Probability 0.000422
0
10 20 30 40 50 60 70 80 90 100

The above line graph and chart is about our dependent variable, which is an
oil price. We see that at the beginning of eighties the till 1998 the oil prices
were decreasing or had a steady trend. After the year 2000 the price of oil
had an increasing trend.

In addition, our first independent variable (X1) is Gross Domestics Product

(GDP) The following graph shows the trend of GDP in the UAE during
1980-2000. We see that, during this period the gross domestic product of the
UAE has increased.
X1
320

280

240

200

160

120

80

40

0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

5
 Histogram and Stats of Gross Domestic Product (GDP)
14
Series: X1
12 Sample 1980 2010
Observations 31
10
Mean 100.3355
Median 63.60000
8 Maximum 315.5000
Minimum 29.60000
6 Std. Dev. 83.52929
Skewness 1.357245
4 Kurtosis 3.545926

Jarque-Bera 9.902554
2
Probability 0.007074
0
25 50 75 100 125 150 175 200 225 250 275 300 325

Moreover, our second dependent variable is inflation rates. The following

line graph shows the inflation rates during 1980-2010. We clearly observe
that the inflation rates were fluctuating during the period. Most recently,
there has been a fall in the inflation rates.
X2
14

12

10

0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Histograms and Stats for the Inflation rates

6
8
Series: X2
7 Sample 1980 2010
Observations 31
6
Mean 4.621774
5 Median 4.265000
Maximum 12.25100
4 Minimum 0.604000
Std. Dev. 3.020559
3 Skewness 0.919427
Kurtosis 3.163146
2
Jarque-Bera 4.402004
1 Probability 0.110692

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13

Furthermore, the following graph belongs to GDP per capita during 1980-
2010. Likewise GDP the GDP per capita also had an increasing trend.
X3
45,000

40,000

35,000

30,000

25,000

20,000

15,000
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

7
10
Series: X3
Sample 1980 2010
8 Observations 31

Mean 31054.03
6 Median 29535.50
Maximum 44283.30
Minimum 18435.20
Std. Dev. 7119.405
4
Skewness 0.226290
Kurtosis 2.134986
2
Jarque-Bera 1.231060
Probability 0.540354
0
20000 25000 30000 35000 40000 45000

The Model
Now we estimate the following model using estimate command in E-views:

Our dependent variable (Y) is oil prices and GDP (x1), GDP per capita (x2),
Inflation (x3) are our independent variable.

𝑦𝑡 = 𝑏1 + 𝑏2 𝑥1𝑡 + 𝑏3 𝑥2𝑡 + 𝑏4 𝑥3𝑡 + 𝑒𝑡

Estimation Command:
=========================
LS Y C X1 X2 X3

Estimation Equation:
=========================
Y = C(1) + C(2)*X1 + C(3)*X2 + C(4)*X3

Substituted Coefficients:
=========================
Y = -7.72031829128 + 0.195254348896*X1 + 1.08964827975*X2 + 0.000432016394882*X3

Dependent Variable: Y

8
Method: Least Squares
Date: 12/21/14 Time: 02:06
Sample: 1980 2010
Included observations: 31

Variable Coefficient Std. Error t-Statistic Prob.

C -7.720318 6.717689 -1.149252 0.2605

X1 0.195254 0.020754 9.407983 0.0000
X2 1.089648 0.521364 2.089993 0.0462
X3 0.000432 0.000266 1.624125 0.1160

R-squared 0.882870 Mean dependent var 30.32258

Adjusted R-squared 0.869855 S.D. dependent var 20.95612
S.E. of regression 7.560045 Akaike info criterion 7.003546
Sum squared resid 1543.166 Schwarz criterion 7.188576
Log likelihood -104.5550 Hannan-Quinn criter. 7.063861
F-statistic 67.83748 Durbin-Watson stat 0.436499
Prob(F-statistic) 0.000000

From the above model we could clearly realize that b1 = -7.72031829128

and b2, b3, and b4 are 0.195254348896, 1.08964827975,
0.000432016394882 respectively.

From the above model we could say that, if xt = 0 then yt =

−7.72031829128 . In addition, if xt increases by one percent then yt will
increase by 0.195254 per. (C.P).

In order to make sure the model is correct we have to check the model with
underlying assumptions of a good model. Following are the results of the
tests done for assumptions of a good model.

Based on Ordinary Least Square (OLS) estimation, the OLS estimator is

BLUE (Best Linear Unbiased Estimator) if (and only if) the estimator is
unbiased and efficient. Therefore, we have to do the following tests:

Test for no misspecification using Romsy RESET test:

We used Romsy RESET test to check for no misspecification of the Model.

The result of the probability of the F-test is smaller than 0.05. Therefore, we
reject the null hypothesis that the model is with biased parameters (no
misspecification).

Ramsey RESET Test

9
Equation: UNTITLED
Specification: Y C X1 X2 X3
Omitted Variables: Squares of fitted values

Value df Probability
t-statistic 4.474594 26 0.0001
F-statistic 20.02199 (1, 26) 0.0001
Likelihood ratio 17.70171 1 0.0000

F-test summary:
Mean
Sum of Sq. df Squares
Test SSR 671.3584 1 671.3584
Restricted SSR 1543.166 27 57.15429
Unrestricted SSR 871.8073 26 33.53105
Unrestricted SSR 871.8073 26 33.53105

LR test summary:
Value df
Restricted LogL -104.5550 27
Unrestricted LogL -95.70410 26

Unrestricted Test Equation:

Dependent Variable: Y
Method: Least Squares
Date: 12/21/14 Time: 02:38
Sample: 1980 2010
Included observations: 31

Variable Coefficient Std. Error t-Statistic Prob.

C 12.56285 6.857323 1.832034 0.0784

X1 -0.155657 0.080018 -1.945278 0.0626
X2 -1.996043 0.796883 -2.504813 0.0189
X3 0.000584 0.000207 2.828250 0.0089
FITTED^2 0.018894 0.004222 4.474594 0.0001

R-squared 0.933828 Mean dependent var 30.32258

Adjusted R-squared 0.923647 S.D. dependent var 20.95612
S.E. of regression 5.790600 Akaike info criterion 6.497039
Sum squared resid 871.8073 Schwarz criterion 6.728327
Log likelihood -95.70410 Hannan-Quinn criter. 6.572433
F-statistic 91.72816 Durbin-Watson stat 0.447110
Prob(F-statistic) 0.000000

Checking for no autocorrelation using Serial correlation LM test:

10
In order to make sure our model is efficient we need to test for no
autocorrelation. It means to test that the values of the error term is
independent.

We can do this test using Serial Correlation LM test. The probability of F-

test is 30 which is bigger than 0.05. Therefore we accept the null hypothesis
which means that the values of the error term in the model are independent.

Breusch-Godfrey Serial Correlation LM Test:

F-statistic 30.86833 Prob. F(2,25) 0.0000

Obs*R-squared 22.06491 Prob. Chi-Square(2) 0.0000

Test Equation:
Dependent Variable: RESID
Method: Least Squares
Date: 12/21/14 Time: 02:42
Sample: 1980 2010
Included observations: 31
Presample missing value lagged residuals set to zero.

Variable Coefficient Std. Error t-Statistic Prob.

C -9.792262 4.113287 -2.380642 0.0252

X1 0.014268 0.011735 1.215906 0.2354
X2 -0.170262 0.296223 -0.574777 0.5706
X3 0.000312 0.000160 1.951080 0.0623
RESID(-1) 0.548580 0.182402 3.007533 0.0059
RESID(-2) 0.517303 0.201668 2.565121 0.0167

R-squared 0.711771 Mean dependent var 3.67E-15

Adjusted R-squared 0.654126 S.D. dependent var 7.172089
S.E. of regression 4.217984 Akaike info criterion 5.888577
Sum squared resid 444.7847 Schwarz criterion 6.166123
Log likelihood -85.27294 Hannan-Quinn criter. 5.979050
F-statistic 12.34733 Durbin-Watson stat 1.836751
Prob(F-statistic) 0.000004

Testing for homoscedasticity using Bruesch Pagan test:

In order to make sure that our model is efficient we also need to check for
homoscedasticity in the model. Checking for homoscedasticity means that to
check that the variance of the error term is constant. We tested this using

11
Bruesch and Pagan test. The F-test result was not desirable (0.07 >0.05),
therefore we adjusted for heteroskedasticity using white method. As for as
its bigger than 0.05 we don’t need to adjust.

Heteroskedasticity Test: Breusch-Pagan-Godfrey

F-statistic 2.584944 Prob. F(3,27) 0.0739

Obs*R-squared 6.917019 Prob. Chi-Square(3) 0.0746
Scaled explained SS 2.588399 Prob. Chi-Square(3) 0.4595

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 12/21/14 Time: 02:47
Sample: 1980 2010
Included observations: 31

Variable Coefficient Std. Error t-Statistic Prob.

C -9.776273 41.49432 -0.235605 0.8155

X1 0.034235 0.128196 0.267055 0.7915
X2 -7.790529 3.220403 -2.419116 0.0226
X3 0.002967 0.001643 1.805589 0.0821

R-squared 0.223130 Mean dependent var 49.77954

Adjusted R-squared 0.136811 S.D. dependent var 50.26205
S.E. of regression 46.69745 Akaike info criterion 10.64517
Sum squared resid 58877.60 Schwarz criterion 10.83020
Log likelihood -161.0001 Hannan-Quinn criter. 10.70549
F-statistic 2.584944 Durbin-Watson stat 1.457109
Prob(F-statistic) 0.073878

Test of Normality Using Histogram Normality Test:

Another underlying important assumption for a good is the normality. This

assumption is important because t-distribution and f-distribution are all
based on normal distribution. Therefore, we tested for normality of the
model using Jarque-Bera test. The probability of the Jarque-Bera test result
is 0.28>0.05, which means that normality conditions is also satisfied in our
model.

12
8
Series: Residuals
7 Sample 1980 2010
Observations 31
6
Mean 3.67e-15
5 Median -3.021671
Maximum 13.62280
4 Minimum -10.61138
Std. Dev. 7.172089
3 Skewness 0.477129
Kurtosis 1.986593
2
Jarque-Bera 2.502738
1 Probability 0.286113

0
-10 -5 0 5 10 15

Ramsey RESET Test

Equation: UNTITLED
Specification: Y C X1
Omitted Variables: Squares of fitted values

Value df Probability
t-statistic 1.742768 49 0.0876
F-statistic 3.037241 (1, 49) 0.0876
Likelihood ratio 3.127245 1 0.0770

F-test summary:
Mean
Sum of Sq. df Squares
Test SSR 13.16956 1 13.16956
Restricted SSR 225.6348 50 4.512697
Unrestricted SSR 212.4653 49 4.336026
Unrestricted SSR 212.4653 49 4.336026

LR test summary:
Value df
Restricted LogL -111.9443 50
Unrestricted LogL -110.3807 49

Unrestricted Test Equation:

Dependent Variable: Y
Method: Least Squares

13
Date: 12/23/14 Time: 22:27
Sample: 1962 2013
Included observations: 52

Variable Coefficient Std. Error t-Statistic Prob.

C 22.88741 10.89797 2.100153 0.0409

X1 -1.564218 0.794994 -1.967584 0.0548
FITTED^2 -1.318971 0.756825 -1.742768 0.0876

R-squared 0.115983 Mean dependent var 3.141617

Adjusted R-squared 0.079900 S.D. dependent var 2.170843
S.E. of regression 2.082313 Akaike info criterion 4.360797
Sum squared resid 212.4653 Schwarz criterion 4.473368
Log likelihood -110.3807 Hannan-Quinn criter. 4.403954
F-statistic 3.214389 Durbin-Watson stat 1.203925
Prob(F-statistic) 0.048785

Descriptive statistics:
Following is the descriptive statistics of our model:

Y C X1 X2 X3
Mean 30.32258 1.000000 100.3355 4.621774 31054.03
Median 23.00000 1.000000 63.60000 4.265000 29535.50
Maximum 93.00000 1.000000 315.5000 12.25100 44283.30
Minimum 12.00000 1.000000 29.60000 0.604000 18435.20
Std. Dev. 20.95612 0.000000 83.52929 3.020559 7119.405
Skewness 1.561212 NA 1.357245 0.919427 0.226290
Kurtosis 4.510372 NA 3.545926 3.163146 2.134986

Jarque-Bera 15.53972 NA 9.902554 4.402004 1.231060

Probability 0.000422 NA 0.007074 0.110692 0.540354

Sum 940.0000 31.00000 3110.400 143.2750 962675.0

Sum Sq. Dev. 13174.77 0.000000 209314.3 273.7133 1.52E+09

Observations 31 31 31 31 31

14
 Conclusion
Oil is an important contributor to the economy of the United Arab Emirates.
The UAE government has been hugely relying on oil revenues since last
decades. Using econometrics approach we have examined the impact of oil
prices on GDP, GDP per capita and inflation rates in the UAE. Using data
during, 1980-2010 we have observed a positive relationship between oil
prices and GDP, GDP per capita and oil prices. This means that, if the oil
prices increase the GDP, GDP per capita, and inflation rates will increase
too. An important conclusion is that, the UAE should decrease its
dependence on oil production to other sectors.

References
1. International Financial Statistics (IFS). Oil Prices, June, 2013 [Data File].
Washington, D.C.: International Monetary Fund.
2. Inflation, 2011, International Monetary Fund, IndexMundi

http://www.indexmundi.com/united_arab_emirates/inflation_rate_(consume
r_prices).html

3. N. Gregory Mankiw. 2010. Macroeconomics (7th edition). Chap 5.

4. World Economic Outlook. Gross Domestic Product, National Accounts,
2014.

15