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Econometric Modelling: Module - 2

This document outlines the steps involved in econometric modelling. It discusses 8 parts and 38 modules focused on topics like simple and multiple regression, time series analysis, and hypothesis testing. The key steps are: 1) Formulating an estimable economic theory-based model. 2) Collecting relevant data. 3) Estimating the model. 4) Evaluating if the model is statistically adequate. 5) Interpreting results. 6) Using the model for analysis if adequate, or revising it if not. It provides an example of estimating Keynes' consumption function model using Indian data from 1990-2020.

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Bharathithasan Saminathan
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54 views

Econometric Modelling: Module - 2

This document outlines the steps involved in econometric modelling. It discusses 8 parts and 38 modules focused on topics like simple and multiple regression, time series analysis, and hypothesis testing. The key steps are: 1) Formulating an estimable economic theory-based model. 2) Collecting relevant data. 3) Estimating the model. 4) Evaluating if the model is statistically adequate. 5) Interpreting results. 6) Using the model for analysis if adequate, or revising it if not. It provides an example of estimating Keynes' consumption function model using Indian data from 1990-2020.

Uploaded by

Bharathithasan Saminathan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Econometric Modelling

MODULE - 2
Prof. Sujata Kar
Assistant Professor
DEPARTMENT OF MANAGEMENT STUDIES IIT ROORKEE

1
Part 1: Introduction to Econometrics Part 5: Univariate Time Series Modeling
Module 1: An Overview Module 25, 26, 27: Problem of Serial Correlation
Module 2: Formulation of Econometric Modelling Module 28: AR, MA & ARMA Processes
Module 3 & 4: Review of Basic Concepts Module 29: Modelling Seasonal Variations
Module 5: Types of Data

Part 2: Overview of Classical Linear Regression Model Part 6: Models with Binary Dependent and Independent
Module 6 & 7: Simple Regression Variables
Module 8: Assumption of Classical Linear Regression Module 30 & 31: Spline Function & Categorical Variables
Module 9: Properties of OLS Estimators Module 32 & 33: Probit, Logit and Multinomial Logit Models
Module 10: Hypothesis Testing

Part 3: Multiple Regression Analysis & Diagnostic Tests


Module 11, 12 & 13: Multiple Regression Part 7: Multivariate Models
Module 14: Problems of Multicollinearity Module 33 & 34: Simultaneous Equations System
Module 15 & 16: Omitted Variables & Parameter Stability Module 35 & 36: Introduction to VARs
Module 17 & 18: Problem of Heteroscedasticity

Part 4: Statistical Inference and Hypothesis Testing


Module 19: t-test Part 8: Modelling Long Run Relationships
Module 20 & 21: Wald test Module 37, 38 & 39: Stationarity & Unit Root Testing
Module 22 & 23: F-test Module 40: Basics of Cointegration
Module 24: Chow test
Formulation of Econometric Modelling
MODULE - 2

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Steps Involved
1. General statement of the problem
1a. Economic Theory
1b. Formulation of an estimable theoretical model

2. Collection of data

3. Model estimation

4. Is the model statistically adequate?


5. Interpret the model
No Yes
Reformulation of the model 6. Use for analysis
Step 1: General Statement of the Problem

• This will usually involve the formulation of a theoretical


model, or intuition from financial theory that two or more
variables should be related to one another in a certain way.

• The model is unlikely to be able to completely capture every


relevant real-world phenomenon, but it should present a
sufficiently good approximation that it is useful for the
purpose at hand.

5
Step 2: Collection of Data relevant to the Model

• The data required may be available through a private or


public organization involved in collection, processing and
dissemination of information either free of cost or against a
payment.

• Alternatively, the required data may be available only via a


survey after distributing a set of questionnaires, which we
call primary data.

6
Step 3: Model Estimation

• Choice of estimation method depends on a large number of


factors like
– The number of variables
– Type of variables (e.g. categorical or non-categorical)
– Statistical properties of the data like distribution
– Size and frequency of the data, to name a few

7
Step 4. Statistical Evaluation of the Model

• What assumptions were required to estimate the parameters


of the model optimally?
• Were these assumptions satisfied by the data or the model?
• Also, does the model adequately describe the data?
• If the answer is ‘yes’, proceed to step 5; if not, go back to
steps 1-3 and either reformulate the model, collect more
data, or select a different estimation technique that has less
stringent requirements.

8
Step 5: Interpret the Model
• Once a model’s statistical adequacy is established, the next step
is to align it with the theoretical interpretation.

• It requires to examine whether the sizes and signs of the


parameter estimates are the same as the one suggested by the
underlying theory.

• If ‘yes’, proceed to step 6; if not, again return to stages 1-3.

9
Step 6: Use of Model

• When a researcher is finally satisfied with the model, it can


then be used for testing the theory specified in step 1, or for
formulating forecasts or suggested courses of action.

• This suggested course of action might be for an individual or as


an input to government policy.

10
Example: Keynes’s Consumption Function
• The theory asserts a relationship between consumption and
income, and claims that the marginal propensity to consume
(MPC) is between zero and one.
• The most common formulation of the consumption function
is a linear relationship, C = α + Xβ, that satisfies Keynes’s
“laws” if β lies between zero and one and if α is greater than
zero.
• These theoretical propositions provide the basis for an
econometric study.
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Example: Keynes’s Consumption Function
• Given an appropriate data set, we could investigate whether the
theory appears to be consistent with the observed “facts.”
• For example, we could see whether the linear specification appears
to be a satisfactory description of the relationship between
consumption and income, and, if so, whether α is positive and β is
between zero and one.
• The model is only a simplification of reality. It will include the salient
features of the relationship of interest but will leave unaccounted
for influences that might well be present but are regarded as
unimportant.
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Consumption Function in the Indian Context, 1990 –
2020

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Step 5 Revisited

• No model could hope to encompass the myriad essentially


random aspects of economic life.
• It is thus also necessary to incorporate stochastic elements.
• As a consequence, observations on a variable will display
variations attributable not only to differences in variables that are
explicitly accounted for in the model, but also to the randomness
of human behavior and the interaction of countless minor
influences that are not.

14
Step 5 Revisited

• It is understood that the introduction of a random


“disturbance” into a deterministic model is not intended
merely to paper over its inadequacies.
• It is essential to examine the results of the study, in an ex
post analysis, to ensure that the allegedly random,
unexplained factor is truly unexplainable.
• If it is not, the model is, in fact, inadequate.

15
References

• Greene, William H (2012). Econometric Analysis. Pearson


Education Limited, England.
• Brooks, Chris (2008). Introductory Econometrics for Finance.
Cambridge University Press, New York.

16
Thank You

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