Multicollinearity, Financial Management

Assignment Help:

 

Multicollinearity

As the degree of correlation between the independent variables increases, the regression coefficients become less reliable. That is, although the independent variables may together explain the dependent variable, but because of multicollinearity the coefficients of the explanatory variables may be rejected. It can happen that the model may be accepted (through ANOVA and the F test), but the individual coefficients may be rejected (through the t test). This is because the interplay among the independent variables reduces the influence of the individual variables in the model. In the extreme case, if two variables are identical, then the influence of each one in the model would be reduced. Multicollinearity does not reduce the accuracy of the model (the predictive powers), but it hurts any sensitivity analysis - if we increase one explanatory variable by one unit, what happens?

This is a subject in itself, but the reader should be aware of the importance of multicollinearity.

Multiple Correlation Coefficients

 

So far we have come across correlation coefficients between two variables X and Y. However in the case of a multiple regression equation like

                   Y = a + b1 X1 + b2 X2

we see that Y can be correlated to both X1 and X2. Hence we can have a coefficient of multiple correlation which will measure the correlation between Y and both X1 and X2.

 

 

 


Related Discussions:- Multicollinearity

Irregular variation in time series analysis, Irregular Variation As the...

Irregular Variation As the name suggests, the movement of the variable is random in nature without consistency and therefore, highly unpredictable. Since this type of irregular

Show the marketing issues, a) Cultural exports are the commercial transfer ...

a) Cultural exports are the commercial transfer of values and ideas from one country to another. Canned crab meat is a popular local fragility in Thailand and Viya Crab Products Co

Stable money measurement, Stable Money Measurement A business entity e...

Stable Money Measurement A business entity enters within numerous transactions in which affect the business in varied ways.  Therefore recording, classification and summarizat

Explain continuous compounding benefit an investor, How does continuous com...

How does continuous compounding benefit an investor? The influence of increasing the number of compounding periods every year is to increase the future value of the investment. Th

Regular payback period, The director of capital budgeting for a firm has re...

The director of capital budgeting for a firm has recognized two mutually exclusive projects, A and B, with the following expected net cash flows:

Binomial model, The option features embedded in many bonds and fixed-...

The option features embedded in many bonds and fixed-income securities have made the binomial interest rate tree approach a valuable model for pricing debt. Binomial

How can we calculate the average inventory, Inventory days (Average in...

Inventory days (Average inventory/Cost of sales) x 365days Average inventory can be arrived by taking this year's and last year's inventory values and dividing by 2 - (Ope

Finance manangement, What is the maximum price that you would be willing to...

What is the maximum price that you would be willing to pay for a constant growth stock that has the following characteristics: (a) Dividend (Has Paid): $3.25, (b) Growth: 7%, and (

Define the modigliani and miller theory of dividends, What is the Modiglian...

What is the Modigliani and Miller theory of dividends?  Explain. The Modigliani-Miller theory of dividends states that dividend theory is not relevant.  They state that it is the

Write a report to outlining the theoretical arguments, QUESTION The Man...

QUESTION The Managing Director of your firm is thinking aloud about an appropriate gearing level for the company: "The consultants I spoke to yesterday explained that some t

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd