Non isotropic (non spherical) disturbances

[1] Heteroskedasticity:
Definition
Consequences
Tests
The assumption of homoskedasticity, or equal (homo) spread, implies:

Var(ei|xi) = 𝜎 2 For all i= 1,2,… Var(e|x) = E(e2|x)-[E(e|x)]2

If: E(e|x) = 0, then
Var(e|x) = E(e2|x) = 𝜎 2
Alternatively, homoskedasticity can be expressed in terms of (y):

If Yi= β0+β1Xi1+…+βkXik + ei

Then: Var (yi/xi) = σ2

Homoskedasticity: →States that variance of the unobservable error, e, conditional on the explanatory variables, is constant
→States that variance of y, given x, does not depend on the values of the independent variables.
→Fails whenever the variance of the unobservables changes across different segments of the population, which are
determined by the different values of the explanatory variables.

In contrast, heteroskedasticity implies:

Var(ei|xi) ≠ 𝜎 2 or Var(ei|xi) = 𝜎𝑖2
Var(yi/xi) ≠ σ2 or Var(yi|xi) = 𝜎𝑖2
Under Homoskedasticity Assumption Spherical Error [1]
If Heteroskedasticity

→The conditional variance of ei increases

→The variance of ei is a constant
as X changes.
as X changes.
→Here, the variances of Yi are not the
𝜎2 →Here, the variances of Yi are the
same. Hence, emerges heteroscedasticity
same for each Xi i=(0,1…n)
E[e]=0
Heteroskedasticity does not cause bias or inconsistency in the OLS estimators of the βj.

∧
𝛽 = (𝑋′𝑋)−1 𝑋′𝑌= 𝛽 + (𝑋′𝑋)−1 𝑋′𝜀
𝑌 = 𝑋𝛽 + 𝜀
∧
𝐸 𝛽 = 𝐸 (𝑋′𝑋)−1 𝑋′(𝑋𝛽 + 𝜀)
∧
𝐸 𝛽 = 𝐸 (𝑋′𝑋)−1 𝑋′𝑋𝛽 + (𝑋′𝑋)−1 𝑋′𝜀
∧
𝐸 𝛽 = 𝐸 𝛽 + (𝑋′𝑋)−1 𝑋′𝜀
∧
𝐸 𝛽 = 𝛽 + (𝑋′𝑋)−1 𝑋′𝐸[𝜀]
∧ …then, under heteroskedasticity OLS estimators
𝐸 𝛽 =𝛽 are unbiased

෣𝛽),
BUT! The estimators: Var( መ are wrong under heteroskedasticity
 …but under heteroskedasticity OLS have the wrong variance. Under Heteroskedasticity

∧ ∧ ∧
2  12 0 0… 0
𝑉𝑎𝑟 𝛽 = 𝐸 𝛽 − 𝐸 𝛽 0  22 0… 0
∧ ∧ ∧
𝑉𝑎𝑟 𝛽 = 𝐸 (𝛽 − 𝛽)(𝛽 − 𝛽)′ E[ ' ] = V = 0 0  32 … :
∧
𝑉𝑎𝑟 𝛽 = 𝐸 (𝛽 − (𝑋´𝑋)−1 𝑋′𝜀 − 𝛽)(𝛽 − (𝑋´𝑋)−1 𝑋′𝜀 − 𝛽)′ : : : :
∧ 0 0 0 … n2
𝑉𝑎𝑟 𝛽 = 𝐸 ((𝑋´𝑋)−1 𝑋′𝜀)(𝜀′𝑋(𝑋´𝑋)−1 )
∧
𝑉𝑎𝑟 𝛽 = (𝑋´𝑋)−1 𝑋′𝐸[𝜀𝜀′]𝑋(𝑋´𝑋)−1
Under homoskedasticity

Variance-Covariance matrix of errors

2 0 0… 0
0 2 0… 0
E[ ' ] = V = 0 0  2… :
: : : :
0 0 0 … 2
Summary:

-OLS standard errors are based on these variances, they are no longer valid for constructing confidence intervals and t statistics.

- OLS t statistics do not have t distributions in the presence of heteroskedasticity, and the problem is not solved by using large sample sizes.

- F statistics are no longer F distributed, and the LM statistic no longer has an asymptotic chi-square distribution.

In summary, the statistics we used to test hypotheses under the Gauss-Markov assumptions are not valid in the presence of
heteroskedasticity.-

Properties of Least Squares in presence of heteroskedasticity

1. Least squares still linear and unbiased.

2. Least squares not efficient.
3. Usual formulas give incorrect standard errors for least squares.
4. Confidence intervals and hypothesis tests based on usual standard errors are wrong
 -Graphical method
-Breusch-Pagan test
-White test
-Golfield-Quandt Test

Graphical Method If there is no a priori or empirical information

Examinate of the OLS residual squared (𝑒Ƹ 2 ) vector to see if they exhibit any systematic pattern as 𝑦ෝ𝑖 or certain regressor 𝑥𝑖𝑘 (suspicious)
changes.
Breusch Pagan test -Graphical method
-Breusch-Pagan test
Consider the mean equation of a MLRM: -White test
-Golfield-Quandt Test
[1]

A test for heteroskedasticity based on a general variance

function when heteroskedasticity is a possibility is:
[2]
Examples:

Where: zi2 zi3,…zis is a set of explanatory variables (possibly different from xi1,
xi3,…xik)

An estimation of [2] (linear versión) based on sample residuals is: If Linear function is present in h(.) , emerges the Breush-Pagan Auxiliar model for
estimating variance
[3] 𝜎ො 2 =
 -Graphical method
Based on [3], define null and alternative hypotheses for a test for -Breusch-Pagan test
heteroskedasticity as: -White test
-Goldfeld-Quandt Test

Since the R2 in [3] measures the proportion of variation in 𝑒෢ 2

𝑖 explained by the z’s,
it is a natural candidate for a test statistic.
Under H0 is true, the sample statistic and its critical value is:
2
𝜒𝑠𝑎𝑚𝑝𝑙𝑒 = N𝑅2
Where: q= restrictions in H0
R2=g.o.f. of BP aux. model
2
𝜒𝑐𝑟𝑖𝑡. ~ 𝜒 2𝑞 ,(𝛼)

And conclude the test according procedure

Breusch-Pagan test can be done implementing F-Statistic :

(𝑆𝑆𝑅𝑅−𝑆𝑆𝑅𝑈𝑅)
ൗ𝑞
Fsample= 𝑆𝑆𝑅𝑈𝑅ൗ
(𝑁−𝐾)

𝐹𝑐𝑟𝑖𝑡 ~𝐹(𝛼,𝑞,𝑛−𝑘)
 -Graphical method
White test -Breusch-Pagan test
Hal White considers an alternative versión of [2] introducing linear, cuadratic -White test
-Goldfeld-Quandt Test
and interaction terms of zik terms, for example; if our starting model is:

𝑦𝑖 = 𝛽0 + 𝛽1 𝑥𝑖1 + 𝛽2 𝑥𝑖2 + 𝑒𝑖

Functional form of variance is:

[4] 𝑒𝑖2 = 𝛼0 + 𝛼1 𝑥𝑖1 + 𝛼2 𝑥𝑖2 + 𝛼3 𝑥𝑖1

2 2
+ 𝛼4 𝑥𝑖2 + 𝛼5 𝑥𝑖1 𝑥𝑖2 + 𝑣𝑖
This equation can be estimated by OLS.

Based on [4], define null and alternative hypotheses for a test for
heteroskedasticity as:

The White test is performed as an F-test or using the

𝜒 2 = N𝑅2 test previously defined.

And conclude the test according procedure

 -Graphical method
Goldfeld-Quandt Test. -Breusch-Pagan test
-White test
→Test for heteroskedasticity is designed for two groups of data with -Goldfeld-Quandt Test
possibly different variances.
→Assumption: the heteroscedastic variance, σ2i , is positively related to
one of the explanatory variables in the regression model.
For simplicity, consider:

Group A : D=1 𝒚𝒊 = 𝜷𝟏 + 𝜷𝟐 𝒙𝒊 + 𝒆𝒊 𝑽𝒂𝒓 𝒆𝒊 = ෝ𝝈𝟐𝑨

𝑦𝑖 = 𝛽0 + 𝛽1 𝑥𝑖1 + 𝛽2 𝑋𝑖2 + 𝑒𝑖 →Xi2=Di =1,0
Group B: D=0 𝒚𝒋 = 𝜷𝟏 + 𝜷𝟐 𝒙𝒋 + 𝒆𝒋 ෝ 𝟐𝑩
𝑽𝒂𝒓 𝒆𝒋 = 𝝈

How does the variance of changes across groups D=1, D=0?

We wish to make the following test:

𝐻0: 𝜎𝐴2 = 𝜎𝐵2 vs H1: 𝜎𝐴2 ≠ 𝜎𝐵2 Where A: D=1

B: D=0

Step 1. Separate groups according to D values and get 2 OLS regressions

Step 2. Get estimators of 𝜎𝐴2 , 𝜎𝐵2

Step 3. Under Ho true our sample statistic:

ෝ2
𝜎 𝐴൘2 2
𝜎 𝐴 ෝ𝐴
𝜎
F= 𝜎ෝ 2 = ෝ𝐵2
𝐵൘ 𝜎
𝜎2
𝐵
And the critical value:
𝐹(𝛼 ,𝑛𝐴 −𝑘𝐴 ,𝑛𝐵 −𝑘𝐵 ) …And conclude the test according procedure
Non spherical disturbances
[1] Heteroskedasticity
Definition
Consequences
Tests