Question

In terms of econometric perspective, what are the assumptions or elements that you need to consider in developing the model for estimation.

Answer 1

The assumptions of ldeveloping the model for estimation is:

• Linear relationship- The relationship should be linear between independent variable and dependent variable.Linear regression is sensitive to outliers so it is necessary to check for any outliers.Thus to test linear relationship use scatter plots.
• Multivariate normality-All the variable is required to be multivariate and normal.Use histogram or Q-Qplot and check normality with goodness of fit test(Kolmogorov-Smirnov test).If data is not normally distributed do a transformation(log-transformation).
• No or little multicollinearity-When independent variable are too highly correlated .
• No auto-correlation- Autocorrelation occurs when the residuals are not independent from each other.Durbin-Watson test. It tests the null hypothesis that the residuals are not linearly auto-correlated. Values between 0 and 4. Values around 2 indicate no autocorrelation.
• Homoscedasticity-meaning residuals are equal across the regression line can be checked using scatter plot. Goldfeld-Quandt Test .Non-linear correlation can used to fix homoscedasticity.