Econometrics

For
Consultants
Data, everywhere
Instructor: Tirthatanmoy Das

Lecture 3
Jun 12, 2024
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Last class…
Software for analysis

Have a project in mind?

Data fitting?

Estimation – bivariate Linear

regression
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Today…

Causality

Multivariate linear
regression

Causal interpretation of
results

Evaluating regression results

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Causality

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 Is this GDPN’s causal
effect?
Are the estimates Is 𝛽!! = 0.92 the causal
confounded? effect?

▷ Theory says 𝐶𝑉𝑁, 𝑃𝑃, 𝐷𝑃𝐶

also affect P, but they are
not included

▷ Could G𝐷𝑃𝑁 pick up their

effects?: possibly yes 5
Notion of causality

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Causality comes Causal effect of 𝑋"
from domain
concepts/theory
establish causal Consider
relationships, not 𝑌 = 𝑓(𝑋" , 𝑋# … 𝑋$ )
from data
▷ Causal relationship: a
Think of thought change in 𝑋" causes a
experiments change in 𝑌, holding the
other 𝑋s constant (ceteris
paribus)
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How to hold other Causal effect of 𝑋"
factors constant
With linearity
𝑢: the regression 𝑌 = 𝐵! + 𝐵" 𝑋" + ⋯ 𝐵$ 𝑋%
error
▷ But if you run
All omitted 𝑌 = 𝐵! + 𝐵" 𝑋"
determinants of 𝑌
▷The you are missing
Any random noise 𝑢 = 𝐵" 𝑋# + ⋯ 𝐵$ 𝑋% 8
Confounding? The imperfect regression
model
Imperfect regression model

𝑌 = 𝐵! + 𝐵" 𝑋 + 𝑢

▷ 𝐵" not causal effect if

Corr 𝑋, 𝑢 ≠ 0

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What can cause Corr 𝑋, 𝑢 ≠ 0

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Investigate the Ask the following for
root cause of the 𝐶𝑜𝑣[𝑋!" , 𝑢] ≠ 0
violation ▷ Any relevant
determinants of 𝑌 are
omitted that could be
correlated with 𝑋?

▷ Using linear when true

relationship is nonlinear

▷ Is 𝑋 measured with error?

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Investigate the Ask the following for
root cause of the 𝐶𝑜𝑣[𝑋!" , 𝑢] ≠ 0
violation ▷ Does 𝑌 also affect 𝑋?
(reverse causality)?

▷ Does your sample (or

data) fail to represent the
population?

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Investigate the Ask the following for
root cause of the 𝐶𝑜𝑣[𝑋!" , 𝑢] ≠ 0
violation

Answer to all these

questions must be NO for
causal interpretation

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Today…
Causality

Multivariate linear regression

Another example – US
manufacturing data?

Causal interpretation of results

Evaluating regression results

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What about How to ensure ‘ceteris
factors that paribus’
affect 𝑌 but are
unobserved or How to account for
unavailable? unobserved or unavailable
factors? Add 𝑋# … 𝑋%

▷ Then add 𝑢, the error

term to the equation

𝑌 = 𝐵! + 𝐵" 𝑋" + ⋯ 𝐵$ 𝑋% + 𝑢
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A more complete Multivariate regression
model emerges
𝑌 = 𝐵! + 𝐵" 𝑋" + ⋯ 𝐵$ 𝑋% + 𝑢

▷ If it is true for all

observations, then its true
for a particular 𝑖 &' unit or
observations
𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(
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What about the ‘pharma’ example?

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GDPN, CVN, PP Is this GDPN’s causal
are indeed effect?
correlated
Answer: possibly yes,
unfortunately!

▷ If 𝐶𝑉𝑁, 𝑃𝑃 are correlated

with G𝐷𝑃𝑁 (is this true here)

▷ If so, 𝛽!! = 0.92 may not

be the true effect of 𝐺𝐷𝑃𝑁
on 𝑃 18
How to deal with New crisis? Causality?
this new crisis
Need to hold 𝐶𝑉𝑁, 𝑃𝑃
constant (‘ceteris paribus’)

▷ Add them in the

regression

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A more complete Multivariate regression
model emerges
The ‘pharma’example
Including other 𝑃(
factors = 𝐵! + 𝐵)*+, 𝐺𝐷𝑃𝑁(
determining + 𝐵-., 𝐶𝑉𝑁( + 𝐵*+- 𝐷𝑃𝐶(
‘pharma’ price + 𝐵/+- 𝐼𝑃𝐶( +𝐵++ 𝑃𝑃( + 𝑢(

where 𝑖 is country identifier

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The model is Multivariate regression
applicable to model
every entity in the
population 𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(

▷ Deterministic: ( E(Y|X)):
XB= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%(

▷ Error: ui
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The model is Multivariate regression
applicable to model
every entity in the
population 𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(

▷ For now: assume u is

uncorrelated with 𝑋" ,
𝑋# … 𝑋$

▷ More later on this

assumption 22
Nomenclature of Multivariate regression
the model model
𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(
where 𝑖 = 1, 2, … , 𝑁

▷ Y: regressand or
outcome or dependent
variable
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Nomenclature of Multivariate regression
the model model
𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(
where 𝑖 = 1, 2, … , 𝑁

▷ X: vector of regressors or
determinants or
independent variable
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Nomenclature of Multivariate regression
the model model
𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(
where 𝑖 = 1, 2, … , 𝑁

▷ u: error term with E 𝑢 = 0

▷ 𝐵! , 𝐵" , … 𝐵$ : regression
coefficients or regression
parameters 25
Nomenclature of Multivariate regression
the model model
𝑌(
= 𝐵! + 𝐵" 𝑋"( + ⋯ + 𝐵$ 𝑋%( + 𝑢(
where 𝑖 = 1, 2, … , 𝑁
▷ N: the number of
observations

▷ Reminder: linearity is
assumed, though it doesn't
have to be 26
Obtaining causal Causal effect
effect from the
regression When 𝑋" changes by 1 unit,
(remember 𝑢 is 𝑌 changes by 𝐵" unit (on
uncorrelated with average), holding ‘ceteris
𝑋s) paribus’
𝜕𝐸[𝑌|𝑋]
𝜕𝑋!
𝜕(𝐵" +𝐵! 𝑋! + 𝐵# 𝑋# + ⋯ 𝐵$ 𝑋% )
=
𝜕𝑋!
= 𝐵!
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Obtaining causal Sample counterpart of
effect from the the regression
regression 𝑌(
(remember 𝑢 is = 𝑏! + 𝑏" 𝑋"( + ⋯ + 𝑏$ 𝑋%( + 𝑒(
uncorrelated with
𝑋s)
▷ where 𝑏! , 𝑏" , … 𝑏% are the
estimates of 𝐵! , 𝐵" , … , 𝐵%

▷ And 𝑒( is the residual

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How to obtain the Least squared method
estimates again
,

𝑀𝑖𝑛0 G(𝑌( − 𝑏! − 𝑏" 𝑋"(

(1(
)"
− 𝑏# 𝑋#( − 𝑏$ 𝑋$(

▷ Take derivatives w.r.t.

coefficients

▷ Set them to zero 29

Note Multivariate regression –
‘pharma’ example
Estimates

▷ The coefficient of 𝐺𝐷𝑃𝑁

changed quite a bit

▷ Does 1.58 represent the

causal effect? Yes, only if
now 𝑢( is uncorrelated with
𝑋𝑠
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Today…

Causality

Multivariate linear
regression

Evaluating regression results

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ Is the regression equation

supported by sound
domain concept/theory?

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ Are all important

variables included in the
equation?

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ Is the functional form

correct? Note we used
linear

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ Is OLS the best estimator

to be used for this
equation? Note that there
could be other estimators

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ Is the regression free from

other econometric
problems? (more later)

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ Is the dataset reasonably

large and accurate and
representative of the
population you are
interested in?
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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ How do the estimates

compare with the
expectations (e.g.,
magnitude, sign)?

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Evaluating the Result evaluations
results from
regression – How reliable are OLS
credibility and results? Check boxes
reliability

✓ How well does the

estimated regression fit the
data?

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 !
Evaluating the Goodness of fit: 𝑅
results from
regression – ▷ 𝑅 : the coefficient of
"
credibility and determination
reliability

▷ Overall measure of
goodness of fit

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 !
How good is the Goodness of fit: 𝑅
fit

▷ Percentage of the total

variation in the 𝑌 that is
explained by the 𝑋s

▷ It is a value between 0
(no fit) and 1 (perfect fit)

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 !
How good is the Goodness of fit: 𝑅
fit
▷ Explained sum squares
"
𝐸𝑆𝑆 = ∑ 𝑌P − 𝑌Q
▷ Residual sum squares
∑ "
𝑅𝑆𝑆 = 𝑒
▷ Total sum squares 𝑇𝑆𝑆 =
∑ 𝑌 − 𝑌Q "

233 533
▷ Then, 𝑅 =
"
=1−( )
433 433 42
 " !
Higher 𝑅 is Misuse of 𝑅
better, but not
the only thing to ▷ Do not attempt to
consider maximize 𝑅" only

▷ Spurious regressions can

"
sometimes give high 𝑅 ,
but has no theoretical
basis

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 " !
Higher 𝑅 is Example: misuse of 𝑅
better, but not
the only thing to Effect of income on
consider Mozzarella consumption
▷ Model 1 𝑅 = 0.88
"

▷ Model 2 𝑅 = 0.97
"

▷ Deaths due to drowning

a determinant? No
▷ Retain Model 1
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Steps for applied regression project

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Applied Applied regression: steps
regression
analysis 6 steps
progresses
according to a
set of steps ▷ Review domain
concepts/literature/theory

▷ Based on domain
concepts/literature/theory
- select the 𝑌 and 𝑋s
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Applied regression Applied regression: steps
analysis
progresses 6 steps
according to a set
of steps
▷ Based on domain
concepts/literature/theory
- select the functional form
(linear for now)

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Applied regression Applied regression: steps
analysis
progresses 6 steps
according to a set
of steps
▷ Hypothesize the
expected signs of the
coefficients – based on
theory

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Applied regression Applied regression: steps
analysis
progresses 6 steps
according to a set
of steps
▷ Collect the data

▷ Inspect and clean the

data

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Applied Applied regression: steps
regression
analysis 6 steps
progresses
according to a
set of steps ▷ Estimate and evaluate
the equation

▷ Document the results

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