Solutions to Midterm Exam Advanced Econometrics 1, 22 October 2014

1.

(a) E[u] = E[E(u|x)] = E[0] = 0, so V[u] = E[u2 ] = E[E(u2 |x)] = E[x] = 21 .

(b) Write
P
N 1 N
i=1 xi ui
b
=+
.
P
2
N 1 N
i=1 xi
Because (ui , xi ) is iid, so is (xi ui , x2i ), so that that the LLN for iid sequences with finite
mean implies
N
1 X
xi ui = E[xu] = E[xE(u|x)] = 0,
N

plim

plim

i=1
N
X

1
N

x2i = E[x2 ] = 13 ,

i=1

b ) = 0.
which implies, by Slutskys Theorem, plim(
(c) Because E[xu] = 0 and V[xu] = E[x2 u2 ] = E[x2 E(u2 |x)] = E[x3 ] = 41 , the CLT for
iid observations implies
N


1 X
d

xi ui N 0, 14 .
N i=1
Using

together with plim N 1

b ) =
N (

N 1/2
N 1

PN

i=1
PN

xi ui

2
i=1 xi

PN

= 13 , and the product normal limit rule, we find

"
#
PN
1
1/2




x
u
N
d
i
i
i=1
b ) =
N 0, 41 2 N 0, 94 ,
N (
PN
2
1
(3)
N
i=1 xi
2
i=1 xi

b N [, 9 /N ].
or
4
(d) The (infeasible) GLS estimator is given by
0

e = (x

1 0

x)

PN
y=

2
i=1 xi yi / i
PN 2 2
i=1 xi / i

PN
=

xi yi /(xi )
Pi=1
N
2
i=1 xi /(xi )

PN

i=1
= PN

yi

i=1 xi

y
.
x

Note that drops out of the formula, so that the GLS estimator is in fact feasible. Using
y = x
+u
, and



d
Nu
N 0, 12 ,
we have

"
#

N
u

d
e ) =
N (
N 0, 21 2 N [0, 2] ,
x

(2)

e = 2/N . So the GLS estimator has a slightly smaller variance than the OLS
or V[]
estimator.
2.

(a) Because Z = [z1 : X2 ], it follows that X2 = ZA0 with A = [0 : IK1 ], and hence
PZ X2 = Z(Z0 Z)1 Z0 ZA0 = ZA0 = X2 ,

so that PZ X = PZ [x1 : X2 ] = [b
x1 : X2 ]. Therefore, the 2SLS estimator is
0 0
1 0 0
b

2SLS = (X PZ PZ X) X PZ PZ y

= [X0 Z(Z0 Z)1 Z0 X]1 X0 Z(Z0 Z)1 Z0 y

1

= (Z0 X)1 Z0 Z(X0 Z)

X0 Z(Z0 Z)1 Z0 y

= (Z0 X)1 Z0 y
b .
=
IV

The second equality follows from the fact that P0Z PZ = PZ because PZ is symmetric and
idempotent.
(b) The assumptions imply that u is independent of Z, hence E[Z0 u] = 0. This can be tested
only if the number of instruments exceeds the number of regressors. In this case it cannot be
0 b = 0 by definition.
b
b = y X
tested, since the 2SLS residuals u
2SLS satisfy Z u
b 2 . The Frisch-Waugh-Lovell theorem implies that
b1 = z1
(c) Write x
b 1 + X2
b
b01 M2 y
b1 )1 x

x01 M2 x
1,2SLS = (b
= (b
1 z01 M2 z1
b1 )1
b1 z01 M2 y,
where M2 = IN X2 (X02 X2 )1 X02 . This shows that a consistent estimator requires that
plim
b1 = 1 6= 0; so if this condition is violated, then there is a weak instrument problem
(or equivalently, a problem with instrument relevance).
3.

(a) We find
LN () =

N
X

ln f (yi |xi ; ) =

i=1

N 
X
i=1

2yi
ln 4 + ln yi 2 ln i ()
i ()


,

and taking first derivatives, using the chain rule and

exp(x0i )
i ()
=
= xi exp(x0i ) = xi i (),

we obtain



N 
N
X
LN () X
2
2yi
yi i ()
sN () =
=
+
xi i () =
2xi
.

i () i ()2
i ()
i=1

i=1

(b) Because of independent observations,

"
0

IN = E[sN ( 0 )sN ( 0 ) ] = E

N
X

(yi
4xi x0i

i=1

#
i ())2
.
i ()2

Using the law of iterated expectations, this reduces to

4

N
X
i=1

 
 


N
N
2
X
X


1
0
0
0 (yi i ()) 
x
=
4
E
x
x
V(y
|x
)
=
2
E
x
x
E E xi xi
.
i
i
i
i
i
i
i

i ()2
i ()2
i=1

Next, using
N
N
X
X
yi
sN ()
yi
0
=
2xi
i ()xi = 2
xi x0i ,
0
2
i ()
i ()

i=1
i=1

i=1

we have
 





N
N
X
X
sN
yi
yi 
0
0
E
( ) = 2
xi xi = 2
E
E xi xi E
xi
i ()
i () 
0 0
i=1
i=1


= 2

N
X



E xi x0i = IN .

i=1

(c) Let
N
QN ()
1 X
hN () =
=
(yi i ())i ()xi .

N
i=1

The essential condition for consistency is E[hN ( 0 )] = 0, and using the law of iterated
expectations it is easy to see that this condition is satisfied, as
E[(yi i ())i ()xi ] = E[i ()xi E(yi i ()|xi )] = 0.
Regarding efficiency, we know that maximum likelihood is asymptotically efficient in the
1
sense that its asymptotic variance matrix is IN
, which is a lower bound for the variance
matrix of consistent and asymptotically normal estimators. Because the NLS estimator is
not equal to the maximum likelihood estimator (it solves other first-order conditions), we do
not expect it to be asymptotically efficient (which would mean asymptotically equivalent to
maximum likelihood). A formal analysis of the degree of inefficiency would require deriving
1
b
an expression for the asymptotic variance of
NLS and comparing it with IN .