Chapter 8

Functional Form, Specification, and Structural Stability

In This Chapter

arrow Understanding how to use and interpret nonlinear regression functions

arrow Transforming common nonlinear functions in economics into linear functions

arrow Testing for specification issues and checking the reliability of your results

You typically choose the dependent variable in a particular analysis based on the economic question or puzzle that you’re interested in exploring and your prior knowledge of economic theory. However, you have to think about several additional questions to determine whether you have a good econometric model. In particular, you need to ask:

check.png What independent variables or factors are likely to affect my outcome or variable of interest (dependent variable)?

check.png Do I expect the variables to have a linear (that is, constant or straight-line) impact on the dependent variable, or are some of them likely to have a nonlinear effect?

Your answers to these questions address what econometricians call ...

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