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

Traditional econometric methodology proceeds along the following lines:

• Statement of theory or hypothesis.
• Specification of the mathematical model of the theory
• Specification of the statistical, or econometric, model
• Obtaining the data
• Estimation of the parameters of the econometric model
• Hypothesis testing
• Forecasting or prediction
• Using the model for control or policy purposes

Assumption 1 requires that the dependent variable is a linear combination of the explanatory variables and the error terms

Assumption 2 requires that explanatory variables x are not allowed to contain any information on the error terms , i.e. it must not be possible to explain through X.

Assumption 3 requires error terms to be independent and identically distributed with expected value to be zero and variance to be constant

Assumption 4 is often listed as a Gauss-Markov assumption and refers to normally distributed error terms in population.