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In: Economics

When looking into covariance, the OLS assumption is that the error term has a population mean...

When looking into covariance, the OLS assumption is that the error term has a population mean of 0. What does the error term mean? what does this: cov(ui, us) ≠ 0 mean?

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Expert Solution

An error term is a residual variable which represents how observed data differs from actual population data.It exists when the regression model does not fully represent the actual relationship between the independent variables and the dependent variables.

Cov.(ui,us)not equal to 0 means observations of the error term are uncorrelated with each other.

It means that one observation of the error term should not predict the next observation. For instance, if the error for one observation is positive and that systematically increases the probability that the following error is positive, that is a positive correlation. If the subsequent error is more likely to have the opposite sign, that is a negative correlation. This problem is known both as serial correlation and autocorrelation.

Rahul Sunny answered 2 years ago
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