ECONOMETRICS IIIB MEMORUNDUM NOV/2022

TSHWANE UNIVERSITY OF TECHNOLOGY

FACULTY OF ECONOMICS AND FINANCE
DEPARTMENT OF ECONOMICS

SUBJECT: ECONOMETRICS IIIB

SUBJECT CODE: EOC30BT
TIME ALLOWED: 3HOURS
Date:4 NOVEMBER 2022
TOTAL MARKS: 100

SPECIAL REQUIREMENTS: CALCULATORS

INSTRUCTIONS TO CANDIDATES: ANSWER ALL THE QUESTIONS
NUMBER OF PAGES: 5
NUMBER OF ANNEXURES: none

COURSES: EXAMINER (S):

NDip in ECONOMIC MANAGEMENT ANALYSIS Mr. MASHAYAMOMBE

Mr. MDLALOSE

Mr. MBANGUTHA

MODERATOR:
Dr. CLANCE

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

Question 1 (20 marks)

1. Define in detail the RESET Test. (4 marks)
Answer:

• RESET Test can be defined as the general test that is used to detect functional form
misspecification
• A multiple regression model suffers from functional form misspecification if it does not
properly account for the relationship between the dependent and the observed
explanatory variables.

2. Compare and contrast the Autoregressive model and Moving Average model. (Hint: use
mathematical notations to get full marks). (6 marks)
Answer:

• Autoregressive model is a model where we assume that 𝑒 are independent on 𝑦0 and

that Є(𝑦0 ) = 0
• 𝑦𝑖 = 𝜌1 𝑦𝑡−1 + 𝑒𝑖
• Moving Average model is a model where 𝑒𝑖 i.i.d sequence with zero mean and some
variance 𝜎𝑒2
• 𝑥 = 𝑒𝑖 + 𝛼1 𝑒𝑖 𝑡−1
3. Compare and contrast contemporaneous exogeneity and strict exogeneity (Hint: use
mathematical notations to get full marks). (6 marks)
Answer:

• Contemporaneous exogeneity is where the error term is uncorrelated with the

explanatory variables on the same period.
• ∈ (𝑢𝑡 /𝑥𝑡 , 𝑥𝑘 ) = 0
• Strict exogeneity is where the error term is uncorrelated with the explanatory variables on
all periods.
• ∈ (𝑢𝑡 /𝑿) = 0
4. Differentiate between a random walk model with a drift and without a drift. (Hint: use
mathematical notations to get full marks). (4 marks)
Answer:

• Random walk model with a drift is a persistent process that contains a clear trend.
• 𝑦𝑡 = 𝛼0 + 𝑦𝑡−1 + 𝑒𝑖
• Random walk without a drift is a process with no clear trend
• 𝑦𝑡 = 𝑦𝑡−1 + 𝑒𝑖

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

Question 2 (22 marks)

Consider the simple regression model with classical measurement error, 𝑦𝑖 = 𝛽0 + 𝛽1 𝑥 ∗ + 𝜇𝑖 ,

where 𝛽0 is statistically not different from zero. 𝑧 = 𝑥 ∗ + 𝑒 . Assume that 𝑥 ∗ is uncorrelated
with 𝑢, 𝑒1 , 𝑒ℎ , and that the measurement errors are pairwise uncorrelated, and have the same
variance, 𝜎𝑒2 . Let 𝑤 = 𝑧, for each observation 𝑖.

𝜎𝑥2∗
1. Show that 𝑝𝑙𝑖𝑚( 𝛽̂1 ) = 𝛽1 { } (Show all your workings) (15 marks)
𝜎𝑥2∗ + 𝜎𝑒2

̂ 𝟏 ) = 𝑪𝒐𝒗(𝒘, 𝒚)/𝑽𝒂𝒓(𝒘). ]
[Hint: The 𝒑𝒍𝒊𝒎 (𝜷

Answer: 𝑪𝒐𝒗 (𝒘, 𝒚)

𝑪𝒐𝒗 (𝒙∗ + 𝒆, 𝜷𝟏 𝒙∗ + 𝝁𝒊 )
𝑪𝒐𝒗 ( 𝒙∗ . 𝜷𝟏 𝒙∗ + 𝒙∗ . 𝝁𝒊 + 𝒆. 𝜷𝟏 𝒙∗ + 𝒆. 𝝁𝒊 )
𝑪𝒐𝒗 ( 𝜷𝟏 𝒙∗ . 𝒙∗ + 𝟎 + 𝟎 + 𝟎) 𝑪𝒐𝒓𝒓𝒆𝒍𝒂𝒕𝒊𝒐𝒏 𝒃𝒆𝒕𝒘𝒆𝒆𝒏 (𝒙∗ . 𝝁𝒊 + 𝒆. 𝜷𝟏 𝒙∗ + 𝒆. 𝝁𝒊 ) = 𝟎
𝑪𝒐𝒗 (𝜷𝟏 𝒙∗ . 𝒙∗ )
𝜷𝟏 𝑪𝒐𝒗 (𝒙∗ . 𝒙∗ )
𝜷𝟏 𝑪𝒐𝒗 (𝒙∗ ). 𝑪𝒐𝒗(𝒙∗ )
𝜷𝟏 𝑽𝒂𝒓 (𝒙∗ )

𝜷𝟏 𝝈𝟐𝒙∗
𝑽𝒂𝒓𝒊𝒂𝒏𝒄𝒆 𝒐𝒇 𝒘
𝒘 = 𝒙∗ + 𝒆
(𝒘)𝟐 = (𝒙∗ )𝟐 + (𝒆)𝟐

∈ (𝒘)𝟐 = ∈ (𝒙∗ )𝟐 + ∈ (𝒆)𝟐

𝑽𝒂𝒓 (𝒘) = 𝑽𝒂𝒓 (𝒙∗ ) + 𝑽𝒂𝒓 (𝒆)

𝑽𝒂𝒓 (𝒘) = 𝝈𝟐𝒙∗ + 𝝈𝟐𝒆

̂ 𝟏 ) = 𝑪𝒐𝒗(𝒘, 𝒚)/𝑽𝒂𝒓(𝒘)
∴ 𝒑𝒍𝒊𝒎 (𝜷
𝟐
̂ 𝟏 ) = { 𝜷𝟐𝟏 𝝈𝒙∗𝟐}
𝒑𝒍𝒊𝒎 (𝜷 𝝈 +𝝈𝒙∗ 𝒆

𝝈𝟐𝒙∗
̂ 𝟏 ) = 𝜷𝟏 { 𝟐
𝒑𝒍𝒊𝒎( 𝜷 𝟐 }
𝝈 𝒙∗ + 𝝈𝒆

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

2. Suppose you are given: 𝑦 = 𝛽0 + 𝛽1 𝑥1 + 𝛽2 𝑥2 + 𝜇 and 𝑥2 = 𝛿0 + 𝛿1 𝑥1 + 𝛾 where

𝐸(𝑢|𝑥1 , 𝑥2 ) = 0 and 𝐸(𝛾|𝑥1 ) = 0
Show that 𝑬(𝒚|𝒙𝟏 ) = (𝜷𝟎 + 𝜷𝟐 𝜹𝟎 ) + ( 𝜷𝟏 + 𝜷𝟐 𝜹𝟏 )𝒙𝟏 (Show all your workings) (7 marks)

𝒚 = 𝜷𝟎 + 𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝒙𝟐 + 𝝁 … … … … 𝟏
𝒙𝟐 = 𝜹𝟎 + 𝜹𝟏 𝒙𝟏 + 𝜸 … … … … … … … . 𝟐
𝑺𝑼𝑩 𝑬𝑸𝟐 𝑰𝑵𝑻𝑶 𝑬𝑸𝟏
𝒚 = 𝜷𝟎 + 𝜷𝟏 𝒙𝟏 + 𝜷𝟐 (𝜹𝟎 + 𝜹𝟏 𝒙𝟏 + 𝜸) + 𝝁
𝒚 = 𝜷𝟎 + 𝜷𝟏 𝒙𝟏 + 𝜷𝟐 (𝜹𝟎 + 𝜹𝟏 𝒙𝟏 + 𝜸) + 𝝁
𝒚 = 𝜷𝟎 + 𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝜹𝟎 + 𝜷𝟐 𝜹𝟏 𝒙𝟏 + 𝜷𝟐 𝜸 + 𝝁
𝒚 = (𝜷𝟎 + 𝜷𝟐 𝜹𝟎 ) + (𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝜹𝟏 𝒙𝟏 ) + (𝜷𝟐 𝜸 + 𝝁)
𝑴𝒖𝒍𝒕𝒊𝒑𝒍𝒚 𝒕𝒉𝒆 𝒘𝒉𝒐𝒍𝒆 𝒇𝒖𝒏𝒄𝒕𝒊𝒐𝒏 𝒘𝒊𝒕𝒉 𝒕𝒉𝒆 𝒆𝒙𝒑𝒆𝒄𝒕𝒂𝒕𝒊𝒐𝒏 𝒔𝒊𝒈𝒏 𝒔𝒊𝒏𝒄𝒆 𝒘𝒆 𝒂𝒓𝒆 𝒍𝒐𝒐𝒌𝒊𝒏𝒈 𝒇𝒐𝒓 𝒕𝒉𝒆 𝒆𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝒗𝒂𝒍𝒖𝒆
Є(𝒚) = Є(𝜷𝟎 + 𝜷𝟐 𝜹𝟎 ) + Є(𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝜹𝟏 𝒙𝟏 ) + Є(𝜷𝟐 𝜸 + 𝝁)
Є(𝒚|𝒙𝟏 ) = (𝜷𝟎 + 𝜷𝟐 𝜹𝟎 ) + (𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝜹𝟏 𝒙𝟏 ) + 𝟎
𝑻𝒉𝒆𝒏 𝒘𝒆 𝒕𝒂𝒌𝒆 𝒐𝒖𝒕 𝒕𝒉𝒆 𝒄𝒐𝒎𝒎𝒐𝒏 𝒇𝒂𝒄𝒕𝒐𝒓 𝒐𝒇 𝒙𝟏 𝒐𝒏 (𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝜹𝟏 𝒙𝟏 )
∴ Є(𝒚|𝒙𝟏 ) = Є(𝜷𝟎 + 𝜷𝟐 𝜹𝟎 ) + (𝜷𝟏 + 𝜷𝟐 𝜹𝟏 )𝒙𝟏

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

Question 3 (18 marks)

1. List and explain in detail time series assumptions (Hint use mathematical notations on your
explanation to get full marks and order is important) (18 marks).
3.1 Linear in Parameters
The stochastic process {(𝒙𝒕𝟏 , 𝒙𝒕𝟐 , … , 𝒙𝒕𝒌 , 𝒚𝒕 ): 𝒕 = 𝟏, 𝟐, … , 𝒏} follows the linear model 𝒚 =
𝜷𝟎 + 𝜷𝟏 𝒙𝟏 + 𝜷𝟐 𝒙𝟐 + 𝝁 , where {𝒖𝒕 : 𝒕 = 𝟏, 𝟐, … , 𝒏} is the sequence of errors or disturbances.
Here, n is the number of observations (time periods)
3.2 No perfect Collinearity
In the sample (and therefore in the underlying time series process), no independent variable
is constant nor a perfect linear combination of the others, 𝑪𝒐𝒓𝒓 (𝒙𝟏 , 𝒙𝟐 ) = 𝟎
3.3 Zero Conditional mean
For each t, the expected value of the error 𝒖𝟏 , given the explanatory variables for all time
periods, is zero. Mathematically, 𝑬(𝒖|𝒙𝟏 , 𝒙𝟐 ) = 𝟎
3.4 Homoskedasticity

Conditional on 𝑿, the variance of 𝒖𝒕 is the same for all 𝒕: 𝑽𝒂𝒓(𝒖|𝒙𝟏 , 𝒙𝟐 ) = 𝝈𝟐 , 𝒕 =

𝟏, 𝟐, … , 𝒏.
3.5 No Serial Correlation
Conditional on 𝑿, the errors in two different time periods are uncorrelated: 𝑪𝒐𝒓𝒓 (𝒖𝒕 , 𝒖𝒔 ) =
𝟎 , for all 𝒕 ≠ 𝒔.
3.6 Normality
The errors 𝒖𝒕 are independent of 𝑿 and are independently and identically distributed as
𝒖~𝑵 (𝟎, 𝝈𝟐 ).

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

Question 4 (20 marks)

Given the following output answer the following questions:
Table 1: Regression Model

Dependent variable: LX
Observations: 20
Variable Coefficient Std. Error t- Statistic
LFDI A 0.087597 2.252600
REER -0.016843 B -2.822109
GGFCF 0.008111 0.013019 C
C D 1.061536 10.47226
R- squared 0.541033
Prob (F- 0.00560
statistic)

Table 2: RESET Test

Ramsey RESET Test

Specification: LX LFDI REER GGFCF C
Value Df Probability
t- statistic 0.540310 21 0.5947
F- statistic 0.291935 (1, 21) 0.5947
Likelihood ratio 0.358954 1 0.5491

1. Fill in the missing values on table 1 above show all your workings to get full marks. (8 marks)

Dependent variable: LX
Observations: 20
Variable Coefficient Std. Error t- Statistic
LFDI A= 0.197 0.087597 2.252600
REER -0.016843 B= 0.00597 -2.822109
GGFCF 0.008111 0.013019 C= 0.6230

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

C D= 11.117 1.061536 10.47226

R- squared 0.541033
Prob (F- 0.00560
statistic)

2. Determine the significance of Growth in Gross Fixed Capital Formation (GGFCF) show all your
steps to get full marks. (5 marks)
𝐻0 : 𝛽1 = 0
𝐻1 : 𝛽1 ≠ 0
∝𝑖 = 5%
𝛽1
𝑡=
𝑠𝑒(𝛽1 )
0.008111
𝑡=
0.013019

𝑡 = 0.6230
Decision
Fail to reject 𝐻0 because the t- test is less than 2 in absolute values.
Conclusion
GGFCF is insignificant

3. Interpret the coefficient of Foreign Direct Investment (LFDI) and Real Effective Exchange Rate
(REER). (HINT: LX stands for Exports). (2 marks)

• There is a positive relationship between LFDI and LX, If LFDI increase by 1%, LX will also
increase by 0.197% holding other factors fixed.
• There is a negative relationship between REER and LX, If REER increases by 1% LX will
decrease by 1.68% holding other factors fixed.
4. Test for functional specification. Show all your steps. (5 marks)
𝐻0 : 𝑁𝑜 𝑚𝑖𝑠𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐𝑎𝑡𝑖𝑜𝑛
𝐻1 : 𝑀𝑖𝑠𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐𝑎𝑡𝑖𝑜𝑛

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

∝𝒊 = 5%
𝑝 − 𝑣𝑎𝑙𝑢𝑒 = 0.5491
Decision
Fail to reject 𝐻0 , 𝑝 − 𝑣𝑎𝑙𝑢𝑒 > ∝𝑖
Conclusion
There is no functional form misspecification

Question 5 (20 marks)

Given the following process:
𝑦𝑡 = 𝜌𝑖 𝑦𝑡−1 + 𝑒𝑡 , ….
1. Calculate the mean of the above process. (3 marks)
𝑦𝑡 = 𝜌𝑖 𝑦𝑡−1 + 𝑒𝑡
Є(𝑦𝑡 ) = Є(𝜌𝑖 𝑦𝑡−1 ) + Є(𝑒𝑡 )
Є(𝑦𝑡 ) = 𝜌𝑖 𝑦𝑡−1 + 0
Є(𝑦𝑡 ) = 𝜌𝑖 𝑦𝑡−1

2. Calculate the variance of the above. (7 marks)

(𝑦𝑡 )2 = (𝜌𝑖 𝑦𝑡−1 )2 + (𝑒𝑡 )2
Є(𝑦𝑡 )2 = Є(𝜌𝑖 𝑦𝑡−1 )2 + Є(𝑒𝑡 )2
𝜎𝑦2𝑡 = 𝜌𝑖2 𝜎𝑦2𝑡 + 𝜎𝑒2𝑡

𝜎𝑦2𝑡 − 𝜌𝑖2 𝜎𝑦2𝑡 = 𝜎𝑒2𝑡

𝜎𝑦2𝑡 (1 − 𝜌𝑖2 ) = 𝜎𝑒2𝑡

𝜎𝑦2𝑡 (1−𝜌𝑖2 ) 𝜎𝑒2𝑡

=
(1−𝜌𝑖2 ) (1−𝜌𝑖2 )

𝜎𝑒2𝑡
𝜎𝑦2𝑡 =
(1−𝜌𝑖2 )

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

3. Given the graph below:

3.1 Determine whether the graph above is nonstationary or stationary. (Explain your answer)
(5 marks)

• Stationary
• The graph always reverts to the mean of zero
• The graph above show that the mean, covariance, and variance is constant.

4. Given the following table below answer the following question

Heteroskedasticity Test: White

F- statistic 0.901310 Prob. F (9, 16) 0.5463
Obs* R- squared 8.747031 Prob. Chi- square 0.4609
(9)
Scaled explained 9.078671 Prob. Chi- square 0.4300
SS (9)

4.1 Test for heteroskedasticity. Show all your steps. (5 marks)

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 ECONOMETRICS IIIB MEMORUNDUM NOV/2022

𝐻0 : 𝐻𝑜𝑚𝑜𝑠𝑘𝑒𝑑𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦
𝐻1 : 𝐻𝑒𝑡𝑒𝑟𝑜𝑠𝑘𝑒𝑑𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦
∝𝒊 = 5%
𝑝 − 𝑣𝑎𝑙𝑢𝑒 = 0.4609
Decision
Fail to reject 𝐻0 , 𝑝 − 𝑣𝑎𝑙𝑢𝑒 > ∝𝑖
Conclusion
The model is not suffering from heteroskedasticity

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