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Suppose i have the following model:

$Y = \alpha_0 + \alpha_1E_1 +\alpha_2E_2$, where $E_1$ indicates first group($1,2..n_1$) individuals, and $E_2$ indicates second group ($n_1,n_1 + 1,...n$)

I want to find OLS of the coefficients. But columns in my matrix X are not independent(because first column consists of one's and second with third columns are dependent from first column)

$(X^tX) = $$ \left( \begin{array}{ccc} n & n_1 & n_2 \\ n_1 & n_1 & 0 \\ n_2 & 0 & n_2 \end{array} \right)$

And because columns are not independent the inverse DNE.

The question is: how can I find OLS in this situation? Are my arguments correct?

Edit: I think, that we can test coefficients separately(if we consider the first group, that regression lools like: $Y = \alpha_0 + \alpha_1E_1$ and we can calculate coefficients without any problems. Is that correct way of solving the problem?

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Usually when you have a categorical variable with $k$ levels, you insert $k-1$ dummy variables in your regression model, to guarantee the full rank of the design matrix in order to calculate the OLS estimates.

That's your case, you have 2 groups, you insert a dummy variable $E_1$ , when this is $0$ it's clear that the individual belongs to the other group.

So the model you wrote in the edit is the proper one for both groups:

if an individual $i$ belongs to the first group you are modeling

$E[Y_i] = \alpha_0 + \alpha_1*1 $

if it belongs to the second one

$E[Y_i] = \alpha_0 $

$E[Y_i]$ indicates expected value

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  • $\begingroup$ Thank you for the comment! But I think, that if individual $i$ belongs to the second group the model is: $Y_i = \alpha_0 + \alpha_2*1$ in my case $\endgroup$ – Daniel Yefimov Jan 6 '17 at 11:59
  • $\begingroup$ @DanielYefimov there is no more $\alpha_2$, you don't need it in the model. If you put $E_2$ in the model then your design matrix is not invertible, and you can't find the $OLS$ estimates. You just need $E_1$ :). Think about it this way: if one individual does not belong to $E_1$ it certainly belongs to the other group, so I don't need another variable telling me if it belongs to the $2^{nd}$ group when I already know it belongs or not to the first one. $\endgroup$ – Tommaso Guerrini Jan 6 '17 at 12:02
  • $\begingroup$ I absolutely agree with you:) But the problem is, that the model in description is given to me, so i can't change it. So, i can conclude, that the inverse of my matrix $X$ DNE? And the solution of this problem is taking the general inverse of matrix? $\endgroup$ – Daniel Yefimov Jan 6 '17 at 12:14
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    $\begingroup$ If you cannot change it, then you should complain to the person who gave it to you, because the model, as explained by Tommaso, does not make sense. In that model, $\alpha_0$ gives you expected $Y$ for units neither in group 1 nor in group 2 (like in any regression: the expected $Y$ when all regressors are set to zero). Since nobody is in that category, you cannot identify all parameters $\alpha_0$, $\alpha_1$, $\alpha_2$ from your data. $\endgroup$ – Christoph Hanck Jan 6 '17 at 14:28

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