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2.1 regression
1.
© 2008 Prentice-Hall,
Inc. Regression Models
2.
© 2009 Prentice-Hall,
Inc. 4 – 2 Introduction Regression analysis is a very valuable tool for data analyst Regression can be used to Understand the relationship between variables Predict the value of one variable based on another variable Examples Determining best location for a new store Studying the effectiveness of advertising dollars in increasing sales volume
3.
© 2009 Prentice-Hall,
Inc. 4 – 3 Introduction Regression analysis is a form of predictive modelling technique which investigates the relationship between a dependent (target) and independent variable (s) (predictor). This technique is used for forecasting, time series modelling and finding the causal effect relationship between the variables.
4.
© 2009 Prentice-Hall,
Inc. 4 – 4 Introduction The variable to be predicted is called the dependent variable Sometimes called the response variable The value of this variable depends on the value of the independent variable Sometimes called the explanatory or predictor variable Independent variable Dependent variable Independent variable = +
5.
© 2009 Prentice-Hall,
Inc. 4 – 5 Introduction Regression models are two types : Simple regression model and multiple regression model. Both are divided into linear and nonlinear models.
6.
© 2009 Prentice-Hall,
Inc. 4 – 6 Scatter Diagram Graphing is a helpful way to investigate the relationship between variables A scatter diagram or scatter plot is often used The independent variable is normally plotted on the X axis The dependent variable is normally plotted on the Y axis
7.
© 2009 Prentice-Hall,
Inc. 4 – 7 Triple A Construction Triple A Construction renovates old homes They have found that the dollar volume of renovation work is dependent on the area payroll SALES ($100,000’s) LOCAL PAYROLL ($100,000,000’s) 6 3 8 4 9 6 5 4 4.5 2 9.5 5 Table 4.1
8.
© 2009 Prentice-Hall,
Inc. 4 – 8 Triple A Construction Figure 4.1 12 – 10 – 8 – 6 – 4 – 2 – 0 – Sales($100,000) Payroll ($100 million) | | | | | | | | 0 1 2 3 4 5 6 7 8 ŷ
9.
© 2009 Prentice-Hall,
Inc. 4 – 9 Triple A Construction Figure 4.1 12 – 10 – 8 – 6 – 4 – 2 – 0 – Sales($100,000) Payroll ($100 million) | | | | | | | | 0 1 2 3 4 5 6 7 8 Ȳ Ŷ Ŷ - Ȳ Y - Ŷ
10.
© 2009 Prentice-Hall,
Inc. 4 – 10 Simple Linear Regression where Y = dependent variable (response) X = independent variable (predictor or explanatory) 0 = intercept (value of Y when X = 0) 1 = slope of the regression line e = random error Regression models are used to test if there is a relationship between variables (predict sales based on payroll) There is some random error that cannot be predicted e XY 10
11.
© 2009 Prentice-Hall,
Inc. 4 – 11 Simple Linear Regression True values for the slope and intercept are not known so they are estimated using sample data XbbY 10 ˆ where Y = dependent variable (response) X = independent variable (predictor or explanatory) b0 = intercept (value of Y when X = 0) b1 = slope of the regression line ^
12.
© 2009 Prentice-Hall,
Inc. 4 – 12 Triple A Construction Triple A Construction is trying to predict sales based on area payroll Y = Sales X = Area payroll The line chosen in Figure 4.1 is the one that minimizes the errors Error = (Actual value) – (Predicted value) YYe ˆ
13.
© 2009 Prentice-Hall,
Inc. 4 – 13 Least Squares Regression Errors can be positive or negative so the average error could be zero even though individual errors could be large. Least squares regression minimizes the sum of the squared errors. Payroll Line Fit Plot 0 2 4 6 8 10 0 2 4 6 8 Payroll ($100.000,000's) Sales ($100,000)
14.
© 2009 Prentice-Hall,
Inc. 4 – 14 Triple A Construction For the simple linear regression model, the values of the intercept and slope can be calculated using the formulas below XbbY 10 ˆ valuesof(mean)average X n X X valuesof(mean)average Y n Y Y 21 )( ))(( XX YYXX b XbYb 10
15.
© 2009 Prentice-Hall,
Inc. 4 – 15 Triple A Construction Y X (X – X)2 (X – X)(Y – Y) 6 3 (3 – 4)2 = 1 (3 – 4)(6 – 7) = 1 8 4 (4 – 4)2 = 0 (4 – 4)(8 – 7) = 0 9 6 (6 – 4)2 = 4 (6 – 4)(9 – 7) = 4 5 4 (4 – 4)2 = 0 (4 – 4)(5 – 7) = 0 4.5 2 (2 – 4)2 = 4 (2 – 4)(4.5 – 7) = 5 9.5 5 (5 – 4)2 = 1 (5 – 4)(9.5 – 7) = 2.5 ΣY = 42 Y = 42/6 = 7 ΣX = 24 X = 24/6 = 4 Σ(X – X)2 = 10 Σ(X – X)(Y – Y) = 12.5 Table 4.2 Regression calculations
16.
© 2009 Prentice-Hall,
Inc. 4 – 16 Triple A Construction 4 6 24 6 X X 7 6 42 6 Y Y 251 10 512 21 . . )( ))(( XX YYXX b 24251710 ))(.(XbYb Regression calculations XY 2512 .ˆ Therefore
17.
© 2009 Prentice-Hall,
Inc. 4 – 17 Triple A Construction 4 6 24 6 X X 7 6 42 6 Y Y 251 10 512 21 . . )( ))(( XX YYXX b 24251710 ))(.(XbYb Regression calculations XY 2512 .ˆ Therefore sales = 2 + 1.25(payroll) If the payroll next year is $600 million 000950$or5962512 ,.)(.ˆ Y
18.
© 2009 Prentice-Hall,
Inc. 4 – 18 Measuring the Fit of the Regression Model Regression models can be developed for any variables X and Y How do we know the model is actually helpful in predicting Y based on X? We could just take the average error, but the positive and negative errors would cancel each other out Three measures of variability are SST – Total variability about the mean SSE – Variability about the regression line SSR – Total variability that is explained by the model
19.
© 2009 Prentice-Hall,
Inc. 4 – 19 Measuring the Fit of the Regression Model Sum of the squares total 2 )( YYSST Sum of the squared error 22 )ˆ( YYeSSE Sum of squares due to regression 2 )ˆ( YYSSR An important relationship SSESSRSST
20.
© 2009 Prentice-Hall,
Inc. 4 – 20 Measuring the Fit of the Regression Model Y X (Y – Y)2 Y (Y – Y)2 (Y – Y)2 6 3 (6 – 7)2 = 1 2 + 1.25(3) = 5.75 0.0625 1.563 8 4 (8 – 7)2 = 1 2 + 1.25(4) = 7.00 1 0 9 6 (9 – 7)2 = 4 2 + 1.25(6) = 9.50 0.25 6.25 5 4 (5 – 7)2 = 4 2 + 1.25(4) = 7.00 4 0 4.5 2 (4.5 – 7)2 = 6.25 2 + 1.25(2) = 4.50 0 6.25 9.5 5 (9.5 – 7)2 = 6.25 2 + 1.25(5) = 8.25 1.5625 1.563 ∑(Y – Y)2 = 22.5 ∑(Y – Y)2 = 6.875 ∑(Y – Y)2 = 15.625 Y = 7 SST = 22.5 SSE = 6.875 SSR = 15.625 ^ ^^ ^^ Table 4.3
21.
© 2009 Prentice-Hall,
Inc. 4 – 21 Sum of the squares total 2 )( YYSST Sum of the squared error 22 )ˆ( YYeSSE Sum of squares due to regression 2 )ˆ( YYSSR An important relationship SSR – explained variability SSE – unexplained variability SSESSRSST Measuring the Fit of the Regression Model For Triple A Construction SST = 22.5 SSE = 6.875 SSR = 15.625
22.
© 2009 Prentice-Hall,
Inc. 4 – 22 Measuring the Fit of the Regression Model Figure 4.2 12 – 10 – 8 – 6 – 4 – 2 – 0 – Sales($100,000) Payroll ($100 million) | | | | | | | | 0 1 2 3 4 5 6 7 8 Y = 2 + 1.25X ^ Y – Y Y – Y ^ YY – Y ^
23.
© 2009 Prentice-Hall,
Inc. 4 – 23 Coefficient of Determination The proportion of the variability in Y explained by regression equation is called the coefficient of determination The coefficient of determination is r2 SST SSE SST SSR r 12 For Triple A Construction 69440 522 625152 . . . r About 69% of the variability in Y is explained by the equation based on payroll (X)
24.
© 2009 Prentice-Hall,
Inc. 4 – 24 Correlation Coefficient The correlation coefficient is an expression of the strength of the linear relationship It will always be between +1 and –1 The correlation coefficient is r 2 rr For Triple A Construction 8333069440 .. r
25.
© 2009 Prentice-Hall,
Inc. 4 – 25 Correlation Coefficient * * * * (a) Perfect Positive Correlation: r = +1 X Y * * * * (c) No Correlation: r = 0 X Y * * * * * * * ** * (d) Perfect Negative Correlation: r = –1 X Y * * * * * * * * * (b) Positive Correlation: 0 < r < 1 X Y * * * * * * * Figure 4.3
26.
© 2009 Prentice-Hall,
Inc. 4 – 26 Using Computer Software for Regression Program 4.1A
27.
© 2009 Prentice-Hall,
Inc. 4 – 27 Using Computer Software for Regression Program 4.1B
28.
© 2009 Prentice-Hall,
Inc. 4 – 28 Using Computer Software for Regression Program 4.1C
29.
© 2009 Prentice-Hall,
Inc. 4 – 29 Using Computer Software for Regression Program 4.1D
30.
© 2009 Prentice-Hall,
Inc. 4 – 30 Using Computer Software for Regression Program 4.1D Correlation coefficient is called Multiple R in Excel
31.
© 2009 Prentice-Hall,
Inc. 4 – 31 Assumptions of the Regression Model 1. Errors are independent 2. Errors are normally distributed 3. Errors have a mean of zero 4. Errors have a constant variance If we make certain assumptions about the errors in a regression model, we can perform statistical tests to determine if the model is useful A plot of the residuals (errors) will often highlight any glaring violations of the assumption
32.
© 2009 Prentice-Hall,
Inc. 4 – 32 Residual Plots A random plot of residuals Figure 4.4A Error X
33.
© 2009 Prentice-Hall,
Inc. 4 – 33 Residual Plots Nonconstant error variance Errors increase as X increases, violating the constant variance assumption Figure 4.4B Error X
34.
© 2009 Prentice-Hall,
Inc. 4 – 34 Residual Plots Nonlinear relationship Errors consistently increasing and then consistently decreasing indicate that the model is not linear Figure 4.4C Error X
35.
© 2009 Prentice-Hall,
Inc. 4 – 35 Estimating the Variance Errors are assumed to have a constant variance ( 2), but we usually don’t know this It can be estimated using the mean squared error (MSE), s2 1 2 kn SSE MSEs where n = number of observations in the sample k = number of independent variables
36.
© 2009 Prentice-Hall,
Inc. 4 – 36 Estimating the Variance For Triple A Construction 71881 4 87506 116 87506 1 2 . .. kn SSE MSEs We can estimate the standard deviation, s This is also called the standard error of the estimate or the standard deviation of the regression 31171881 .. MSEs
37.
© 2009 Prentice-Hall,
Inc. 4 – 37 Testing the Model for Significance When the sample size is too small, you can get good values for MSE and r2 even if there is no relationship between the variables Testing the model for significance helps determine if the values are meaningful We do this by performing a statistical hypothesis test
38.
© 2009 Prentice-Hall,
Inc. 4 – 38 Testing the Model for Significance We start with the general linear model e XY 10 If 1 = 0, the null hypothesis is that there is no relationship between X and Y The alternate hypothesis is that there is a linear relationship (1 ≠ 0) If the null hypothesis can be rejected, we have proven there is a relationship We use the F statistic for this test
39.
© 2009 Prentice-Hall,
Inc. 4 – 39 Testing the Model for Significance The F statistic is based on the MSE and MSR k SSR MSR where k = number of independent variables in the model The F statistic is MSE MSR F This describes an F distribution with degrees of freedom for the numerator = df1 = k degrees of freedom for the denominator = df2 = n – k – 1
40.
© 2009 Prentice-Hall,
Inc. 4 – 40 Testing the Model for Significance If there is very little error, the MSE would be small and the F-statistic would be large indicating the model is useful If the F-statistic is large, the significance level (p-value) will be low, indicating it is unlikely this would have occurred by chance So when the F-value is large, we can reject the null hypothesis and accept that there is a linear relationship between X and Y and the values of the MSE and r2 are meaningful
41.
© 2009 Prentice-Hall,
Inc. 4 – 41 Steps in a Hypothesis Test 1. Specify null and alternative hypotheses 010 :H 011 :H 2. Select the level of significance (). Common values are 0.01 and 0.05 3. Calculate the value of the test statistic using the formula MSE MSR F
42.
© 2009 Prentice-Hall,
Inc. 4 – 42 Steps in a Hypothesis Test 4. Make a decision using one of the following methods a) Reject the null hypothesis if the test statistic is greater than the F-value from the table in Appendix D. Otherwise, do not reject the null hypothesis: 21 ifReject dfdfcalculated FF ,, kdf 1 12 kndf b) Reject the null hypothesis if the observed significance level, or p-value, is less than the level of significance (). Otherwise, do not reject the null hypothesis: )( statistictestcalculatedvalue- FPp value-ifReject p
43.
© 2009 Prentice-Hall,
Inc. 4 – 43 Triple A Construction Step 1. H0: 1 = 0 (no linear relationship between X and Y) H1: 1 ≠ 0 (linear relationship exists between X and Y) Step 2. Select = 0.05 625015 1 625015 . . k SSR MSR 099 71881 625015 . . . MSE MSR F Step 3. Calculate the value of the test statistic
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Inc. 4 – 44 Triple A Construction Step 4. Reject the null hypothesis if the test statistic is greater than the F-value in Appendix D df1 = k = 1 df2 = n – k – 1 = 6 – 1 – 1 = 4 The value of F associated with a 5% level of significance and with degrees of freedom 1 and 4 is found in Appendix D F0.05,1,4 = 7.71 Fcalculated = 9.09 Reject H0 because 9.09 > 7.71
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Inc. 4 – 45 F = 7.71 0.05 9.09 Triple A Construction Figure 4.5 We can conclude there is a statistically significant relationship between X and Y The r2 value of 0.69 means about 69% of the variability in sales (Y) is explained by local payroll (X)
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Inc. 4 – 46 r2 coefficient of determination The F-test determines whether or not there is a relationship between the variables. r2 (coefficient of determination) is the best measure of the strength of the prediction relationship between the X and Y variables. • Values closer to 1 indicate a strong prediction relationship. • Good regression models have a low significance level for the F-test and high r2 value.
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Inc. 4 – 47 Coefficient Hypotheses Statistical tests of significance can be performed on the coefficients. The null hypothesis is that the coefficient of X (i.e., the slope of the line) is 0 i.e., X is not useful in predicting Y P values are the observed significance level and can be used to test the null hypothesis. Values less than 5% negate the null hypothesis and indicate that X is useful in predicting Y For a simple linear regression, the test of the regression coefficients gives the same information as the F-test.
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Inc. 4 – 48 Analysis of Variance (ANOVA) Table When software is used to develop a regression model, an ANOVA table is typically created that shows the observed significance level (p-value) for the calculated F value This can be compared to the level of significance () to make a decision DF SS MS F SIGNIFICANCE Regression k SSR MSR = SSR/k MSR/MSE P(F > MSR/MSE) Residual n - k - 1 SSE MSE = SSE/(n - k - 1) Total n - 1 SST Table 4.4
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Inc. 4 – 49 ANOVA for Triple A Construction Because this probability is less than 0.05, we reject the null hypothesis of no linear relationship and conclude there is a linear relationship between X and Y Program 4.1D (partial) P(F > 9.0909) = 0.0394
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Inc. 4 – 50 Multiple Regression Analysis Multiple regression models are extensions to the simple linear model and allow the creation of models with several independent variables Y = 0 + 1X1 + 2X2 + … + kXk + e where Y = dependent variable (response variable) Xi = ith independent variable (predictor or explanatory variable) 0 = intercept (value of Y when all Xi = 0) I = coefficient of the ith independent variable k = number of independent variables e = random error
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Inc. 4 – 51 Multiple Regression Analysis To estimate these values, a sample is taken the following equation developed kk XbXbXbbY ...ˆ 22110 where = predicted value of Y b0 = sample intercept (and is an estimate of 0) bi = sample coefficient of the ith variable (and is an estimate of i) Yˆ
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Inc. 4 – 52 Jenny Wilson Realty Jenny Wilson wants to develop a model to determine the suggested listing price for houses based on the size and age of the house kk XbXbXbbY ...ˆ 22110 where = predicted value of dependent variable (selling price) b0 = Y intercept X1 and X2 = value of the two independent variables (square footage and age) respectively b1 and b2 = slopes for X1 and X2 respectively Yˆ She selects a sample of houses that have sold recently and records the data shown in Table 4.5
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Inc. 4 – 53 Jenny Wilson Realty SELLING PRICE ($) SQUARE FOOTAGE AGE CONDITION 95,000 1,926 30 Good 119,000 2,069 40 Excellent 124,800 1,720 30 Excellent 135,000 1,396 15 Good 142,000 1,706 32 Mint 145,000 1,847 38 Mint 159,000 1,950 27 Mint 165,000 2,323 30 Excellent 182,000 2,285 26 Mint 183,000 3,752 35 Good 200,000 2,300 18 Good 211,000 2,525 17 Good 215,000 3,800 40 Excellent 219,000 1,740 12 Mint Table 4.5
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Inc. 4 – 54 Jenny Wilson Realty Program 4.2 21 289944146631 XXY ˆ
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Inc. 4 – 55 Evaluating Multiple Regression Models Evaluation is similar to simple linear regression models The p-value for the F-test and r2 are interpreted the same The hypothesis is different because there is more than one independent variable The F-test is investigating whether all the coefficients are equal to 0
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Inc. 4 – 56 Evaluating Multiple Regression Models To determine which independent variables are significant, tests are performed for each variable 010 :H 011 :H The test statistic is calculated and if the p-value is lower than the level of significance (), the null hypothesis is rejected
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Inc. 4 – 57 Jenny Wilson Realty The model is statistically significant The p-value for the F-test is 0.002 r2 = 0.6719 so the model explains about 67% of the variation in selling price (Y) But the F-test is for the entire model and we can’t tell if one or both of the independent variables are significant By calculating the p-value of each variable, we can assess the significance of the individual variables Since the p-value for X1 (square footage) and X2 (age) are both less than the significance level of 0.05, both null hypotheses can be rejected
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Inc. 4 – 58 Binary or Dummy Variables Binary (or dummy or indicator) variables are special variables created for qualitative data A dummy variable is assigned a value of 1 if a particular condition is met and a value of 0 otherwise The number of dummy variables must equal one less than the number of categories of the qualitative variable
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Inc. 4 – 59 Jenny Wilson Realty Jenny believes a better model can be developed if she includes information about the condition of the property X3 = 1 if house is in excellent condition = 0 otherwise X4 = 1 if house is in mint condition = 0 otherwise Two dummy variables are used to describe the three categories of condition No variable is needed for “good” condition since if both X3 and X4 = 0, the house must be in good condition
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Inc. 4 – 60 Jenny Wilson Realty Program 4.3
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Inc. 4 – 61 Jenny Wilson Realty Program 4.3 Model explains about 90% of the variation in selling price F-value indicates significance Low p-values indicate each variable is significant 4321 369471623396234356658121 XXXXY ,,,.,ˆ
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Inc. 4 – 62 Model Building The best model is a statistically significant model with a high r2 and few variables As more variables are added to the model, the r2-value usually increases For this reason, the adjusted r2 value is often used to determine the usefulness of an additional variable The adjusted r2 takes into account the number of independent variables in the model When variables are added to the model, the value of r2 can never decrease; however, the adjusted r2 may decrease.
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Inc. 4 – 63 Model Building SST SSE SST SSR 12 r The formula for r2 The formula for adjusted r2 )/(SST )/(SSE 1 1 1Adjusted 2 n kn r As the number of variables increases, the adjusted r2 gets smaller unless the increase due to the new variable is large enough to offset the change in k
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Inc. 4 – 64 Model Building It is tempting to keep adding variables to a model to try to increase r2 The adjusted r2 will decrease if additional independent variables are not beneficial. As the number of variables (k) increases, n-k-1 decreases. This causes SSE/(n-k-1) to increase which in turn decreases the adjusted r2 unless the extra variable causes a significant decrease in SSE The reduction in error (and SSE) must be sufficient to offset the change in k
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Inc. 4 – 65 Model Building In general, if a new variable increases the adjusted r2, it should probably be included in the model In some cases, variables contain duplicate information When two independent variables are correlated, they are said to be collinear (e.g., monthly salary expenses and annual salary expenses) When more than two independent variables are correlated, multicollinearity exists When multicollinearity is present, hypothesis tests for the individual coefficients are not valid but the model may still be useful
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Inc. 4 – 66 Nonlinear Regression In some situations, variables are not linear Transformations may be used to turn a nonlinear model into a linear model * * ** ** * * * Linear relationship Nonlinear relationship * * ** ** * * ** *
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Inc. 4 – 67 Colonel Motors The engineers want to use regression analysis to improve fuel efficiency They have been asked to study the impact of weight on miles per gallon (MPG) MPG WEIGHT (1,000 LBS.) MPG WEIGHT (1,000 LBS.) 12 4.58 20 3.18 13 4.66 23 2.68 15 4.02 24 2.65 18 2.53 33 1.70 19 3.09 36 1.95 19 3.11 42 1.92 Table 4.6
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Inc. 4 – 68 Colonel Motors Figure 4.6A 45 – 40 – 35 – 30 – 25 – 20 – 15 – 10 – 5 – 0 – | | | | | 1.00 2.00 3.00 4.00 5.00 MPG Weight (1,000 lb.) Linear model 110 XbbY ˆ
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Inc. 4 – 69 Colonel Motors Program 4.4 A useful model with a small F-test for significance and a good r2 value
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Inc. 4 – 70 Colonel Motors Figure 4.6B 45 – 40 – 35 – 30 – 25 – 20 – 15 – 10 – 5 – 0 – | | | | | 1.00 2.00 3.00 4.00 5.00 MPG Weight (1,000 lb.) Nonlinear model 2 210 weightweight )()(MPG bbb
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Inc. 4 – 71 Colonel Motors The nonlinear model is a quadratic model The easiest way to work with this model is to develop a new variable 2 2 weight)(X This gives us a model that can be solved with linear regression software 22110 XbXbbY ˆ
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Inc. 4 – 72 Colonel Motors Program 4.5 A better model with a smaller F-test for significance and a larger adjusted r2 value 21 43230879 XXY ...ˆ
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Inc. 4 – 73 Cautions and Pitfalls If the assumptions are not met, the statistical test may not be valid Correlation does not necessarily mean causation Your annual salary and the price of cars may be correlated but one does not cause the other Multicollinearity makes interpreting coefficients problematic, but the model may still be good Using a regression model beyond the range of X is questionable, the relationship may not hold outside the sample data
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Inc. 4 – 74 Cautions and Pitfalls t-tests for the intercept (b0) may be ignored as this point is often outside the range of the model A linear relationship may not be the best relationship, even if the F-test returns an acceptable value A nonlinear relationship can exist even if a linear relationship does not Just because a relationship is statistically significant doesn't mean it has any practical value
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