1. Chow Test Kevin Ardon Colt Van Eaton Dayana Zhappassova

2. Savings and Personal Disposable Income Estimating a savings function that relates savings (Y) to disposable personal income (X) We can run a simple regression and obtain OLS estimates. However, by doing so we are assuming the relationship between savings and the disposable personal income did not change over 26 years. Might not be a valid assumption, considering the recession in 1982 in the USA Might disturb the relationship between savings and disposable personal income

3. Savings and Personal Disposable Income

7. Structural Break Test To test for the structural break we can use the Chow Test This allows us to test the hypothesis that some or all of the regression coefficients are different in different subsets of the data. There are two ways of using the Chow test to test for the structural change Unrestricted approach Restricted approach

8. Unrestricted Approach

10. Restricted Approach

13. Savings and Personal Disposable Income

15. Savings and Personal Disposable Income Example

17. MATLAB

18. Chow Predictive Test

20. Limitation of Chow Test There are some limitations when using the Chow test 1.The assumptions underlying the test must be fulfilled a.Error terms are normally distributed and variances are homoscedastic If heteroscedastic → use Wald test 2.Chow test will not show if the two regressions are different on account of the intercepts, slopes or both

21. Dummy Variable Alternative

22. Limitation of Chow Test (cont’d) The final limitation of the Chow test 3.Chow test assumes we know the point of structural break a.If point of structural break is unknown, alternative method is needed Recursive Least Squares

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