1. Lecture 9- Chapter 19 Multiple regression

2. 19.1 Introduction In this chapter we extend the simple linear regression model and allow for any number of independent variables. We expect to build a model that fits the data better than the simple linear regression model.

3. We will use computer printout to –Assess the model How well does it fit the data? Is it useful? Are any required conditions violated? –Employ the model interpreting the coefficients predictions using the prediction equation estimating the expected value of the dependent variable

4. Coefficients Dependent variableIndependent variables Random error variable 19.2 Model and required conditions We allow for k independent variables to potentially be related to the dependent variable: y =  0 +  1 x 1 +  2 x 2 + …+  k x k + 

5. y =  0 +  1 x X y X2X2 1 The simple linear regression model allows for one independent variable x. y =  0 +  1 x +  The multiple linear regression model allows for more than one independent variable. y =  0 +  1 x 1 +  2 x 2 +  Note how the straight line becomes a plane and... y =  0 +  1 x 1 +  2 x 2

6. X y X2X2 1 … a parabola becomes a parabolic surface.

7. –The mean of  is zero: E() = 0. –The standard deviation of  is a constant (  ). –The errors are independent. –The errors are independent of the independent variable x. –The error  is normally distributed. These conditions are required in order to –estimate the model coefficients with desirable properties –test hypotheses about the model coefficients –assess the resulting model. Required conditions for the error variable 

8. –If the model passes the assessment tests, use it to interpret the coefficients and generate predictions. –Assess the model fit and usefulness using the model statistics. –Diagnose violations of required conditions. Try to remedy problems identified. 19.3 Estimating the coefficients and assessing the model The procedure –Obtain the model coefficients and statistics using statistical computer software.

9. The Holiday Inns group is planning an expansion. Management wishes to predict which sites are likely to be profitable. Several areas where predictors of profitability can be identified are: –competition –market awareness –demand generators –demographics –physical quality. Example

10. Profitability Competition Market awareness CustomersCommunity Physical Margin RoomsNearestOffice space University enrolment IncomeDistance to town Distance to downtown Median household income Distance to the nearest Holiday Inn Number of hotel/motel rooms within 3 km of the site

11. –Data were collected from 100 randomly- selected Holiday Inns and run for the following suggested model: Margin =     Rooms   Nearest  Office  Enrolment +  5 Income +  6 Distance to town + 

12. Excel output This is the sample regression equation (sometimes called the prediction equation) MARGIN = 72.455 – 0.0076 ROOMS – 1.646 NEAREST + 0.02 OFFICE + 0.212 ENROLMT – 0.413 INCOME + 0.225 DISTTWN Let us assess this equation

13. –We need to estimate the standard error of estimate –where k is the number of X (independent) variables. –Compare s  to the mean value of y from the printout, standard error = 5.5121 calculating the mean value of y we have –It seems s  is not particularly small (relative to y values). –Can we conclude that the model does not fit the data well? Standard error of estimate

14. –The definition of R 2 is –From the printout R 2 = 0.5251 –52.51% of the variation in the measure of profitability is explained by the linear regression model formulated above. –When adjusted for degrees of freedom, adjusted R 2 = 1 – [SSE/(n – k – 1)]/[SS y /(n – 1)] = 49.44% Coefficient of determination R 2

15. We pose the question: Is there at least one independent variable linearly related to the dependent variable? To answer the question, we test the hypotheses H 0 :  1 =  2 = … =  k = 0 H A : at least one  i is not equal to zero If at least one  i is not equal to zero, the model is useful. Testing the utility of the model

16. To test these hypotheses we perform an analysis of variance procedure. The F-test –Construct the F-statistic –Rejection region F>F ,k,n-k-1 MSE MSR F  MSR = SSR/k MSE = SSE/(n – k – 1) SST = [Variation in y] = SSR + SSE. Large F results from a large SSR. Then much of the variation in y is explained by the regression model. The null hypothesis should be rejected; thus the model is useful. Required conditions must be satisfied.

17. Excel provides the following ANOVA results Example – continued SSE SSR MSE MSR MSR/MSE

18. Excel provides the following ANOVA results Example - continued F ,k,n-k-1 = F 0.05,6,100-6-1 = 2.17 F = 17.14 > 2.17 Also the p-value (significance F) = 3.03382(10) -13 Clearly  = 0.05 > 3.03382(10) -13 and the null hypothesis is rejected. Conclusion: There is sufficient evidence to reject the null hypothesis in favour of the alternative hypothesis. At least one of the  i is not equal to zero. Thus, at least one independent variable is linearly related to y. This linear regression model is useful.

19. This is the intercept, the value of y when all the variables take the value zero. Since the data range of all the independent variables do not cover the value zero, do not interpret the intercept. In this model, for each additional 1 000 rooms within 3 km of the Holiday Inn, the operating margin decreases on average by 7.6% (assuming the other variables are held constant). Interpreting the coefficients

20. – In this model, for each additional km that the nearest competitor is to the Holiday Inn, the average operating margin decreases by 1.65%. – For each additional 1 000 sq-metre of office space, the average increase in operating margin will be 0.02%. – For each additional thousand students MARGIN increases by 0.21%. – For each additional $1 000 increase in median household income, MARGIN decreases by 0.41%. – For each additional km to downtown, MARGIN increases by 0.23% on average.

21. The hypothesis for each  i Excel printout H 0 :  i = 0 H A :  i  0 Test statistic d.f. = n - k -1 Testing the coefficients

22. The model can be used by: –producing a prediction interval for the particular value of y, for a given set of values of x i. –producing an interval estimate for the expected value of y, for a given set of values of x i. The model can be used to learn about relationships between the independent variables x i and the dependent variable y, by interpreting the coefficients  i Using the regression equation

23. Example – continued Predict the MARGIN of an inn at a site with the following characteristics: –3 815 rooms within 3 km –closest competitor 3.4 km away –476 000 sq-metre of office space –24 500 university students –$39 000 median household income –3.6 km distance to downtown centre. MARGIN = 72.455 – 0.0076 (3815) – 1.646 (3.4) + 0.02( 476) +0.212 (24.5) – 0.413( 39) + 0.225 (3.6) = 37.1%

24. The required conditions for the model assessment to apply must be checked. –Is the error variable normally distributed? –Is the error variance constant? –Are the errors independent? –Can we identify outliers? –Is multicollinearity a problem? 19.4 Regression diagnostics – II Draw a histogram of the residuals or use a  2 test for normality. Plot the residuals versus y. ^ Plot the residuals versus the time periods. Calculate the paired correlation coefficients of the independent variables.

25. Example 19.2 –A real estate agent believes that a house selling price can be predicted using the house size, number of bedrooms and lot size. –A random sample of 100 houses was drawn and data recorded. –Analyse the relationship among the four variables.

26. Solution –The proposed model is PRICE =  0 +  1 BEDROOMS +  2 H-SIZE + 3 LOTSIZE +  Excel solution The model is useful, but no variable is significantly related to the selling price!

27. –when regressing the price on each independent variable alone, it is found that each variable is strongly related to the selling price. –Multicollinearity is the source of this problem. –Multicollinearity causes two kinds of difficulties: The t statistics appear to be too small. The  coefficients cannot be interpreted as ‘slopes’. However,

28. Remedying violations of required conditions –Non-normality or heteroscedasticity can be remedied using transformations on the y variable. –The transformations can improve the linear relationship between the dependent variable and the independent variables. –Many computer software systems allow us to make the transformations easily.

29. A brief list of transformations –y’ = log y (for y > 0) Use when the s  increases with y, or Use when the error distribution is positively skewed. –y’ = y 2 Use when the s 2  is proportional to E(y), or Use when the error distribution is negatively skewed. –y’ = y 1/2 (for y > 0) Use when the s 2  is proportional to E(y). –y’ = 1/y Use when s 2  increases significantly when y increases beyond some value.

30. Example 19.3 –A statistics lecturer wanted to know whether time limit affect the marks on a quiz. –A random sample of 100 students was split into five groups. –Each student did a quiz, but each group was given a different time limit. See data below. MarksMarks Analyse these results and include diagnostics.

31. This model is useful and provides a good fit. The errors seem to be normally distributed. The model tested: MARK =  0 +  1 TIME + 

32. The standard error of estimate seems to increase with the predicted value of y. Two transformations are used to remedy this problem: 1. y’ = log e y 2. y’ = 1/y

33. Let us see what happens when a transformation is applied: 40,18 40,23 40, 3.135 40, 2.89 Log e 23 = 3.135 Log e 18 = 2.89 The original data, where ‘mark’ is a function of ‘time’ The modified data, where LogMark is a function of ‘time’

34. The new regression analysis and diagnostics are: The model tested: LOGMARK =  ’ 0 +  ’ 1 TIME +  ’ Predicted LogMark = 2.1295 + 0.021 time This model is useful and provides a good fit.

35. The errors seem to be normally distributed. The standard error still changes with the predicted y, but the change is smaller than before.

36. Let TIME = 55 minutes LogMark = 2.1295 + 0.0217 time = 2.1295 + 0.0217(55) = 3.323 To find the predicted mark, take the antilog: Mark = antilog e 3.323 = e 3.323 = 27.743 How do we use the modified model to predict?

37. 19.5 Regression diagnostics – III (time series) Durbin–Watson test –This test detects first-order autocorrelation between consecutive residuals in a time series. –If autocorrelation exists, the error variables are not independent. Residual at time t

38. + + + + + + + + + + Residuals Time Positive first-order autocorrelation occurs when consecutive residuals tend to be similar. Then the value of d is small (< 2). Positive first-order autocorrelation Negative first-order autocorrelation + + + + 0 0 Residuals Time + Negative first-order autocorrelation occurs when consecutive residuals tend to differ markedly. Then the value of d is large (> 2).

39. –One-tail test for positive first-order autocorrelation If d < d L there is enough evidence to show that positive first-order correlation exists. If d > d U there is not enough evidence to show that positive first-order correlation exists. If d is between d L and d U the test is inconclusive. –One-tail test for negative first-order autocorrelation If d > 4 – d L negative first-order correlation exists. If d < 4 – d U negative first-order correlation does not exist. If d is between 4 – d U & 4 – d L the test is inconclusive.

40. –Two-tail test for first-order autocorrelation If d 4 – d L first-order autocorrelation exists. If d falls between d L and d U or between 4 – d U and 4 – d L the test is inconclusive. If d falls between d U and 4 – d U there is no evidence for first-order autocorrelation. dLdL dUdU 20 4 4-d U 4-d L First-order correlation exists First-order correlation exists Inconclusive test Inconclusive test First-order correlation does not exist First-order correlation does not exist

41. –How does the weather affect the sales of lift tickets in a ski resort? –Data of the past 20 years sales of tickets, along with the total snowfall and the average temperature during Christmas week in each year, were collected. –The model hypothesised was TICKETS =  0 +  1 SNOWFALL+  2 TEMPERATURE +  –Regression analysis yielded the following results: Example

42. The model seems to be very poor: The model seems to be very poor: The fit is very low (R-square = 0.12) It is not valid (signif. F = 0.33) No variable is linearly related to sales Diagnosis of the required conditions resulted in the following findings: Diagnosis of the required conditions resulted in the following findings:

43. Residual over time Residual vs. predicted y The errors are not independent The error variance is constant The errors may be normally distributed The error distribution

44. Test for positive first-order autocorrelation: n = 20, k = 2. From the Durbin–Watson table we have: d L = 1.10, d U = 1.54. The statistic d = 0.59. Conclusion: because d < d L there is sufficient evidence to infer that positive first-order autocorrelation exists. Using the computer – Excel Tools > Data Analysis > Regression (check residual option then OK) Tools > Data Analysis Plus > Durbin–Watson statistic > Highlight range of residuals from regression run > OK The residuals

45. The modified regression model TICKETS =  0 +  1 SNOWFALL +  2 TEMPERATURE +  3 YEARS +  The autocorrelation has occurred over time. Therefore a time-dependent variable added to the model may correct the problem. All the required conditions are met for this model. The fit of this model is high: R 2 = 0.74. The model is useful. Significance F = 5.93 E – 5. SNOWFALL and YEARS are linearly related to ticket sales. TEMPERATURE is not linearly related to ticket sales.