Transcript Chapter 6

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ECONOMETRICS
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CHAPTER
6
Dummy Variable Regression Models
Dummy, or indicator, variables take on values of 0 or 1
to indicate the presence or absence of a quality.
They can be included in regressions
just like quantitative variables.
Yi = B1 + B2 Di + B3Xi + ui
Di = 1 for female
0 for male
OR
Di = 1 for prior to 2001
0 for 2001 and later
A Dummy Variable Indicates Change in Intercept
Y
Yi = 60 + 30 Di - 0.4 Xi + ui
120
If D = 0
100
Y = 60 + 30 D - 0.4 X
80
D=1
60
40
D=0
20
Y = 60 – 0.4 X
If D = 1
Y = 60 + 30 D - 0.4 X
20 40 60 80 100 120
Y = 90 - 0.4 X
X
B2=30 is the differential intercept coefficient.
A Dummy Variable Can Allow for Change in Slope, Too
Y
Yi = 60 + 30 Di – 0.4 Xi + 0.3(DiXi) + ui
120
100
If D = 0
D=1
80
Y = 60 + 30 D – 0.4 X + 0.3 DX
Y = 60 – 0.4 X
60
40
D=0
20
20 40 60 80 100 120
If D = 1
Y = 60 + 30 D – 0.4 X + 0.3 DX
Y = 60 – 0.1 X
X
B4=0.3 is the differential slope coefficient.
Variables with More than Two Classes
Don’t allow the dummy variable to take on multiple values:
Yi = B1 + B2 Di + B3Xi + ui
Di = 0 for first quarter
1 for second quarter
2 for third quarter
3 for fourth quarter

This assumes a pattern in the effect that might not exist.
Instead, use several indicator variables.
Yi = B1 + B2 D2i + B3D3i + B4D4i + B5Xi + ui
D2i = 1 if 2nd qrt
0 otherwise
D3i = 1 if 3rd qrt
0 otherwise
D4i = 1 for 4th qrt
0 otherwise
