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I stumbled over a rather simple result of OLS regression which is

$$ Var[\hat\beta] = \sigma^2(X^TX)^{-1} $$ where $\sigma$ is the variance of the error term $u$ and $X$ is the regressor matrix.

I first just accepted the proof in my textbook but now I am thinking that it either uses sloppy notation or I am missing something. $\hat\beta$ is the estimated and $\beta$ is the true parameter (assuming unbiasedness).

It states that

\begin{align} Var[\hat\beta] &= E[(\hat\beta - \beta)(\hat\beta-\beta)^T] \\ &= E[(X^TX)^{-1}X^Tuu^TX(X^TX)^{-1}] \\ &= (X^TX)^{-1}X^T E[uu^T] X(X^TX)^{-1} \end{align}

but $X$ was only assumed to be exogenous and not non-stochastic. Under this assumption I think $X$ cannot be dragged outside the expectation operator.

Momentarily, I think that it should be $Var[\hat\beta|X]$ to make sense. Is that the case? My web research couldn't clarify this. I only found similar derivations to the above without further explainations.

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  • $\begingroup$ This looks like frequentist statistics and thus data or observations should be random, not the inputs or regressors, shouldn't they? The data are random because there is random error added. $\endgroup$ – gwr Nov 28 '15 at 11:40
  • $\begingroup$ A couple of pages before this derivation the book authors state that assuming $X$ as nonstochastic is "frequently not a reasonable assumption" . Therfore, this assumption was relaxed to exogeneity. $\endgroup$ – Alex Nov 28 '15 at 11:46
  • $\begingroup$ In section 6 of this tutorial it gives that the simplification only holds if $X$ is assumed non-stochastic. $\endgroup$ – gwr Nov 28 '15 at 12:03
  • $\begingroup$ This would support my assumption that if we assume only exogeneity the correct notation would have been $Var[\hat\beta|X]$ and not $Var[\hat\beta]$. But why is this fact skipped so often? Seems not correct to me. $\endgroup$ – Alex Nov 28 '15 at 13:42
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    $\begingroup$ It seems that under the assumptions usually made the usual estimate for the variance given that $X$ is fixed is also an unbiased estimate of the unconditional estimate when $X$ is random as is shown here. Maybe that helps. $\endgroup$ – gwr Nov 28 '15 at 15:14
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You are right that the conditional variance is not generally the same as the unconditional one. By the variance decomposition lemma, which says that, for r.v.s $X$ and $Y$

$$ Var(X)=E[Var(X|Y)]+Var[E(X|Y)] $$ Translated to our problem, $$ Var(\widehat{\beta})=E[Var(\widehat{\beta}|X)]+Var[E(\widehat{\beta}|X)] $$ Now, using that OLS is conditionally unbiased (under suitable assumptions like exogeneity assumed here), we have $$ E(\widehat{\beta}|X)=\beta $$ and thus $$ Var[E(\widehat{\beta}|X)]=0,$$ as $\beta$ is a constant, so that $$ Var(\widehat{\beta})=E[Var(\widehat{\beta}|X)] $$ or $$Var(\widehat{\beta})=E[\sigma^2(X'X)^{-1}].$$

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  • $\begingroup$ Oh, just realized that this is pretty much what the link of @gwr says... $\endgroup$ – Christoph Hanck Nov 28 '15 at 16:37
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    $\begingroup$ +1 I am only a biased Bayesian and thus have forgotten long ago about what unbiased estimators really are good for and thus had to use secondary material to answer anyways. As a pun: Your concise answer is better for the long run... :-) $\endgroup$ – gwr Nov 28 '15 at 16:50

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