Topics: Econometrics, Regression analysis, Statistics Pages: 8 (2445 words) Published: January 3, 2013
Econometrics is the application of mathematics and statistical methods to economic data and described as the branch of economics that aims to give empirical content to economic relations. [1] More precisely, it is "the quantitative analysis of actual economic phenomena based on the concurrent development of theory and observation, related by appropriate methods of inference."[2] An influential introductory economics textbook describes econometrics as allowing economists "to sift through mountains of data to extract simple relationships."[3] The first known use of the term "econometrics" (in cognate form) was by Paweł Ciompa in 1910. Ragnar Frisch is credited with coining the term in the sense that it is used today.[4] Econometrics is the unification of economics, mathematics, and statistics. This unification produces more than the sum of its parts.[5] Econometrics adds empirical content to economic theory allowing theories to be tested and used for forecasting and policy evaluation Basic econometric models: linear regression

The basic tool for econometrics is the linear regression model. In modern econometrics, other statistical tools are frequently used, but linear regression is still the most frequently used starting point for an analysis.[7] Estimating a linear regression on two variables can be visualized as fitting a line through data points representing paired values of the independent and dependent variables. For example, consider Okun's law, which relates GDP growth to the unemployment rate. This relationship is represented in a linear regression where the change in unemployment rate () is a function of an intercept (), a given value of GNP growth multiplied by a slope coefficient and an error term, :

The unknown parameters and can be estimated. Here is estimated to be -1.77 and is estimated to be 0.83. This means that if GNP grew one point faster, the unemployment rate would be predicted to drop by .94 points (-1.77*1+0.83). The model could then be tested for statistical significance as to whether an increase in growth is associated with a decrease in the unemployment, as hypothesized. If the estimate of were not significantly different from 0, we would fail to find evidence that changes in the growth rate and unemployment rate were related. [edit] Theory

See also: Estimation theory
Econometric theory uses statistical theory to evaluate and develop econometric methods. Econometricians try to find estimators that have desirable statistical properties including unbiasedness, efficiency, and consistency. An estimator is unbiased if its expected value is the true value of the parameter; It is consistent if it converges to the true value as sample size gets larger, and it is efficient if the estimator has lower standard error than other unbiased estimators for a given sample size. Ordinary least squares (OLS) is often used for estimation since it provides the BLUE or "best linear unbiased estimator" (where "best" means most efficient, unbiased estimator) given the Gauss-Markov assumptions. When these assumptions are violated or other statistical properties are desired, other estimation techniques such as maximum likelihood estimation, generalized method of moments, or generalized least squares are used. Estimators that incorporate prior beliefs are advocated by those who favor Bayesian statistics over traditional, classical or "frequentist" approaches. [edit] Gauss-Markov theorem

The Gauss-Markov theorem shows that the OLS estimator is the best (minimum variance), unbiased estimator assuming the model is linear, the expected value of the error term is zero, errors are homoskedastic and not autocorrelated, and there is no perfect multicollinearity. [edit] Linearity

The dependent variable is assumed to be a linear function of the variables specified in the model. The specification must be linear in its parameters. This does not mean that there must be a linear relationship between the independent and dependent...
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