ECON2206 ASSIGNMENT 2

Problem 1
a) True. The presence of heteroskedasticity indicates that the standard errors of the
indicators are biased. The t and F tests become invalid because they no longer follow
the t-distribution and F distribution respectively.
b) False. Not all cases overestimate the standard errors of estimators. In the presence
of heteroskedasticity, the OLS estimators are still unbiased but they incorrectly
describe the sampling distribution.
c) True. Both the White and the Breusch-Pagan test require the regression of the
squared error term on the independent variables (for Breusch-Pagan) or the fitted
and squared fitted values (for the White Test).

Problem 2
a) The Regression Specification Error Test (RESET) is used to detect general functional
form misspecification in the linear regression model. It adds non-linear polynomials
to test whether they help explain the dependent variable. If it does, the model is
misspecified.
b)

^
y i=3.10095.1706 x 2 i1.165 x 3i R R2=0.9038

Restricted Model
Unrestricted Model

^
y i=3.39495.3265 x 2 i1.2339 x3 i 0.0117 ^
y i2 +0.004 ^
y i3 R UR2=0.
9069

n=55 and q=2 where k = number of variables in unrestricted model including B 0=5
The RESET test requires the calculation of the F statistic:

R 2r
ur 2

F=

0.9038
0.9069

10.9069 / ( 555 )

0.8324382

0.83(2 dp)

c) In the RESET test the hypotheses are:

H0: 1i=2i=0 (Correct specification is linear)
H1: 1i2i0 (Correct specification is non-linear)
The critical value from the F distribution table is F(2, 50) = 3.19 with =5%
From part (b), F = 0.83. Since F < F(2, 50) or 0.83 < 3.19, we fail to reject H 0.
Therefore the test detected no misspecification.

Problem 3
a) log(price) = -1.297041 + 0.1679667log(lotsize) + 0.7002324log(sqrft) +
0.369583bdrms
(0.6512837)
(0.0382812)
(0.0928653)
(0.0275313)
n=88, Adj-R2=0.630
b)
b)

Using the display command it is found that log(price) = 5.9928985

c) Using the regress command provides the following model:
log(price) = 0.2637439 + 0.0074379log(lotsize) 0.1032385log(sqrft) + 0.0338391bdrms +
1.043065log(assess)
(0.5696647)
(0.0385615)
(0.1384304)
(0.0220983)
(0.151446)
n = 88, Adj-R2 = 0.7619

Testing the hypotheses using the F test:

H0: 1=2=3=0, 4=1
H1: At least one of the
restrictions is not valid
F statistic: F(4, 83) = 0.67
p-value: 0.6162
Therefore we reject the null
hypothesis with a 5% significance
level as p-value 0.6162 > 0.05.
This indicates that the variables are jointly significant.
d) Using the regress command provides the following model:
log(price) = -0.1614737 + 1.013407log(assess)
(0.3460738)
(0.0604609)
n = 88, Adj-R2 = 0.7629

Despite taking variables out in the OLS equation, this model demonstrates the highest
adjusted R2 level out of the three. This is explained by our results in part (c) which
demonstrates that the variables were not jointly significant. Additionally, log(assess) is
shown to be individually significant as shown by the t stat of 16.76 in (d) and 6.89 in (c).
Therefore this model would be the most preferred model to use to estimate housing prices.
For every 1% increase in assess increases price by about 1.01%