# OTHER TECHNICAL ISSUES IN REGRESSION ANALYSIS

If the data to be analyzed by linear regression violate one or more of the linear regression assumptions, the results of the analysis may be incorrect or misleading. For example, if the assumption of independence is violated, then linear regression is not appropriate. If the assumption of normality is violated or outliers are present, then the linear regression goodness-of-fit test may not be the most powerful or informative test available, and this could mean the difference between detecting a linear fit or not. A nonparametric, robust, or resistant regression method, a transformation, a weighted least-squares linear regression, or a nonlinear model may result in a better fit. If the population variance for the dependent variable is not constant, a weighted least-squares linear regression or a transformation of the dependent variable may provide a means of fitting a regression adjusted for the inequality of the variances. Often, the impact of an assumption violation on the linear regression result depends on the extent of the violation (such as how nonconstant the variance of the dependent variable is, or how skewed the dependent variable population distribution is). Some small violations may have little practical effect on the analysis, while other violations may render the linear regression result useless and incorrect.

Other potential assumption violations include:

• Lack of independence in the dependent variable.
• Independent variable is random, not fixed.
• Special problems with few data
• Special problems with regression through the origin.

#### Lack of Independence in the Dependent Variable

Whether the independent-variable values are independent of each other is generally determined by the structure of the experiment from which they arise. The dependent-variable values collected over time may be autocorrelated. For serially correlated dependent-variable values, the estimates of the slope and intercept will be unbiased, but the estimates of their variances will not be reliable and, hence, the validity of certain statistical goodness-of-fit tests will be flawed. An ARIMA model may be better in such circumstances.

#### The Independent Variable Is Random, Not Fixed

The usual linear regression model assumes that the observed independent variables are fixed, not random. If the independent values are not under the control of the experimenter (i.e., are observed but not set), and if there is in fact underlying variance in the independent variable, but the variance is the same, the linear model is called an errors-in-variables model or a structural model. The least-squares fit will still give the best linear predictor of the dependent variable, but the estimates of the slope and intercept will be biased (will not have expected values equal to the true slope and variance). A stochastic forecast model may be a better alternative here.

#### Special Problems with Few Data Points or Micronumerosity

If the number of data points is small (also termed micronumerosity), it may be difficult to detect assumption violations. With small samples, assumption violations such as non-normality or heteroskedasticity of variances are difficult to detect even when they are present. With a small number of data points, linear regression offers less protection against the violation of assumptions. With few data points, it may be hard to determine how well the fitted line matches the data, or whether a nonlinear function would be more appropriate.

Even if none of the test assumptions are violated, a linear regression on a small number of data points may not have sufficient power to detect a significant difference between the slope and zero, even if the slope is nonzero. The power depends on the residual error, the observed variation in the independent variable, the selected significance alpha level of the test, and the number of data points. Power decreases as the residual variance increases, decreases as the significance level is decreased (i.e., as the test is made more stringent), increases as the variation in observed independent variable increases, and increases as the number of data points increases. If a statistical significance test with a small number of data points produces a surprisingly nonsignificant probability value, then lack of power may be the reason. The best time to avoid such problems is in the design stage of an experiment when appropriate minimum sample sizes can be determined, perhaps in consultation with an econometrician, before data collection begins.

#### Special Problems with Regression Through the Origin

The effects of nonconstant variance of the dependent variable can be particularly severe for a linear regression when the line is forced through the origin: the estimate of variance for the fitted slope may be much smaller than the actual variance, making the test for the slope nonconservative (more likely to reject the null hypothesis that the slope is zero than what the stated significance level indicates). In general, unless there is a structural or theoretical reason to assume that the intercept is zero, it is preferable to fit both the slope and intercept.

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