Have difficulty understanding Matlab's Ridge regression

I am confused by Matlab's documentation of Ridge regression at http://www.mathworks.com/help/stats/ridge-regression.html and couldn't figure it out by myself.

On that page, the Introduction to Ridge Regression part all look good to me. However, in the following example, why do we need the line D = x2fx(X,'interaction');? It seems to map the features (x1, x2, x3) to 2-degree polynomial space (x1, x2, x3, x1x2, x1x3, x2x3) and then do regression on it. If I want to train on the original features, should I just use [x1, x2, x3] instead of D?

And what is the right way to interpret the "ridge trace" there? I saw that as the ridge parameter k goes up, the absolute value of coefficients learned decreases and converges to two groups. But if I use [x1, x2, x3] instead of D, I could not observe similar trends.

Finally, to use the parameters learned to predict new data, should I just call ytest = Xtest * betahet on a centered and normalized matrix Xtest with mean = 0 and stddev = 0?

There's no reason you can't use ridge regression on the linear model. I'm guessing the example shows the interaction model because there is higher collinearity there (compare corr(X) with corr(D)) so the effect of the ridge regression is more pronounced. For the linear model you would have to choose much larger values of the ridge parameter to see substantial shrinkage.

To make predictions, you'll need to apply the centering and scaling parameters that were computed from the training data, not standardize the test data separately. If you type "help ridge" you should see instructions for computing a coefficient vector B0 that can be applied directly to the test data without re-scaling.

x2fx() produces a design matrix from a data matrix.

Often the former is offhandedly introduced as being "the matrix of explanatory variables" (e.g. Wikipedia) which makes it sound identical to the data matrix, and the formula for linear regression with either will look the same. Indeed, if you don't care about interactions or non-linear terms then your design matrix can simply be your data matrix for ridge().

Suppose you wanted these terms however, i.e. you want to fit a model of the form y = a(A) + b(B) + c(AB) + d(A^2) + e(B^2) (forgive my notation, capitals are IVs). From that equation it should be clear that one can achieve this using the same linear regression math, having computed extra columns for the input matrix corresponding to output coefficients c, d, and e. A design matrix is a data matrix with those extra columns if desired.

So MathWorks were just doing that to add richness/context to their example. Probably this served the didactic purpose of underscoring how your input matrix doesn't need a constant term (like regress() does and what x2fx() returns). It complicates the example however.

TLDR: If you don't want interaction or quadratic terms then you can use ridge() essentially like regress(), except with the extra k argument and without a column of all 1s appended to the data matrix for the constant term.