A Complete Guide to the Futures Market, 2nd Edition

Appendix A

Introduction to Regression Analysis

Theory helps us bear our ignorance of fact.

—George Santayana

■ Basics

Regression analysis is concerned with describing and evaluating the relationship between a given variable and one or more other variables. For example, we might be interested in describing the relationship between the pig crop (number of pigs born during a given period) and the hog slaughter level in the following six-month period.¹ The relationship between these variables is illustrated in Figure A.1. Each point in Figure A.1 represents a single observation or year. The location of a point along the horizontal axis is determined by the December–May pig crop, while its placement along the vertical axis is determined by the June–November hog slaughter level. Note that there is a clear relationship between these two variables: large hog slaughter levels correspond to large pig crop levels. In this example, hog slaughter is the dependent variable in that hog slaughter depends on the pig crop, but not vice versa, and the pig crop is the independent, or explanatory, variable. The primary goal of regression analysis is to define a mathematical relationship between the dependent variable and the independent variable(s).

Figure A.1 June–November Hog Slaughter vs. December–May Pig Crop (Thousands)

Perhaps the most basic underlying assumption in the standard regression ...