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

Cash flow of reverse convertibles, (a) Let's presume that the firm may defa...

(a) Let's presume that the firm may default only on last coupon payment date and that when this take place stock price would be less than some predetermined price K at the expira

Present value, Present V alue This is the current value of a fu...

Present V alue This is the current value of a future payment or stream of payments. The present value is calculated by applying a discount (capitalization) rate to the

Determine the no-arbitrage price, 1.  Suppose Bank one offers a risk free i...

1.  Suppose Bank one offers a risk free interest rate of 5.5% on both savings and loans, and Bank Enn offers a risk free interest rate of 6% on both savings and loans. What arbitra

Examine about environmental analysis, Examine about Environmental (external...

Examine about Environmental (external) analysis "A study that considers potential environmental effects during planning phase before an investment is made or an operation start

Explain the bird in the hand theory of cash dividends, Explain the bird in ...

Explain the bird in the hand theory of cash dividends. The bird in the hand dividends theory states that dividends received now are better as compared to a promise of future divi

Why do we need to learn finance, Why do we need to learn finance The qu...

Why do we need to learn finance The questions that you may thinking about right now are "Why do we need to learnfinance?  Shall we not leave it to people who are going to speci

Investment appraisal , what are the limitations of using projected data

what are the limitations of using projected data

Quarterly earnings studies, Quarterly Earnings Studies The Quarterly Ea...

Quarterly Earnings Studies The Quarterly Earnings Studies are a part of time-series analysis. These studies aim at predicting future returns for a stock based on publicly avail

Capital budgeting case study, RWE Enterprises is a small manufacturer in Ad...

RWE Enterprises is a small manufacturer in Adelaide South Australia, feed suppliments for cattle. New production line NPV, Payback period and discounted payback period

Placement on career path, Placement on career path: The next step of t...

Placement on career path: The next step of the career planning process is to place an individual on a chosen career path. A career path is the logical possible sequence of pos

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