Econometrics - Multi-Collinearity - Ch. 8 Gujarati - 2020

This video is based on Chapter 8 of D.N. Gujarati & Porter’s : Essentials of Econometrics. The Topic discussed is the Problem of Multicollinearity in Regression and its analysis. I have discussed the following issues:

1. Nature of the Problem of Multicollinearity: Perfect MC vs Imperfect MC : Consequences on parameter estimation - A heuristic approach towards understanding the MC

2. Theoretical & Practical Consequences of MC : No impact of Imperfect MC on BLUE characteristics of OLS estimates. However we face some possible practical issues: Larger variances, wider CI, Insignificant T ratios, Higher R squares, Sensitive OLS estimates , wrong signs of coefficients.

3. Detection of MC:

a. High R square but few significant parameters
b. High pairwise correlation among explanatory variables-Correlation Matrix
c. Examination of partial correlations
d. Auxiliary Regression of each explanatory variable on all others: finding out if the relationship (R square through F test) is significant.
e. Variance Inflation Factor (VIF): how higher MC leads to higher Auxiliary regression R square which feeds into the formula of each parameter variance. As a Rule of Thumb if VIF more than 10 : Problem of MC is severe.

4. Remedial Measures of MC-
a. Dropping a Variable: This can lead to model mis-specification and biased estimates of OLS
b. Acquiring additional data
c. Rethinking the Model: Changing the functional form to reduce the impact of MC
d. Using prior information about some parameters: however, does this assumption hold valid for the current period or data
e. Transformation of Data
f. Principal Component Analysis
g. Ridge Regression


This Chapter is extremely important from the point of examination for Semester IV students of Economics Hons. & BBE of Delhi University. While students of Masters, MBA, UGC-NET, IES Exam would also find it useful in their course of preparation.

My Best Wishes & Happy Learning😊

The Pink Professor
Siddharth Rathore
Assistant Professor
Department of Economics
Gargi College
University of Delhi