We want to estimate the coefficient k in the Permanent IncomeHypothesisCį = kY;*, 0 < k<1where C; is the consumption and Y* is the permanent income.However, we do not observe the permanent income. Instead, wecan only use a proxy variable Y₁;, which is contaminated by aclassical measurement error (i.e., Y; Y;* + e; and e; is theclassical measurement error). Then the OLS estimator of k obtainedby regressing C on Y and a constant isbiased downwardbiased toward zerobiased upwardunbiased-

The reason is that the OLS estimate of k is biased upward if the error term, e, is correlated with…

Answered: We want to estimate the coefficient k…

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We want to estimate the coefficient k in the Permanent Income Hypothesis C₁ = kY,0

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

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Question

We want to estimate the coefficient k in the Permanent Income
Hypothesis
Cį = kY;*, 0 < k<1
where C; is the consumption and Y* is the permanent income.
However, we do not observe the permanent income. Instead, we
can only use a proxy variable Y₁;, which is contaminated by a
classical measurement error (i.e., Y; Y;* + e; and e; is the
classical measurement error). Then the OLS estimator of k obtained
by regressing C on Y and a constant is
biased downward
biased toward zero
biased upward
unbiased
-

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