Question: Consider the following system of two equations y1t = 0 + 1 y2t + 2X1t + 3X2t + u1t (6.97) y2t = 0 + 1

Consider the following system of two equations y1t = α0 + α1 y2t + α2X1t + α3X2t + u1t (6.97)

y2t = β0 + β1 y1t + β2X1t + u2t (6.98)

(a) Explain, with reference to these equations, the undesirable consequences that would arise if (6.97) and (6.98) were estimated separately using OLS.

(b) What would be the effect upon your answer to

(a) if the variable y1t had not appeared in (6.98)?

(c) State the order condition for determining whether an equation which is part of a system is identified. Use this condition to determine whether (6.97) or (6.98) or both or neither are identified.

(d) Explain whether indirect least squares (ILS) or two-stage least squares (2SLS) could be used to obtain the parameters of (6.97)

and (6.98). Describe how each of these two procedures (ILS and 2SLS) are used to calculate the parameters of an equation. Compare and evaluate the usefulness of ILS, 2SLS and IV.

(e) Explain briefly the Hausman procedure for testing for exogeneity.

AppendixLO1

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