# Teaching Graduate (and Undergraduate) Econometrics: Some Sensible Shifts to Improve Efficiency, Effectiveness, and Usefulness

## Abstract

**:**

## 1. Introduction

- (1)
- The abstract equations and high-level math should be replaced with real examples;
- (2)
- There should be greater emphasis on choosing the best set of control variables for causal interpretation of some treatment variable;
- (3)
- There should be a shift towards randomized control trials and quasi-experimental methods (e.g., regression-discontinuities and difference-in-difference methods), as these are the methods most often used by economists these days.

- A.
- Increase emphasis on some regression basics (“holding other factors constant” and regression objectives)
- B.
- Reduce emphasis on getting the standard errors correct
- C.
- Adopt new approaches for teaching how to recognize biases
- D.
- Shift focus to the more practical quasi-experimental methods
- E.
- Add emphasis on interpretations on statistical significance and p-values
- F.
- Advocate less complexity
- G.
- Add a simple ethical component.

## 2. Why a Redesign Is Needed

- There are concerns on the validity of much economic research;
- Biases in coefficient estimates threaten a model’s validity much more than biases in standard errors;
- The conventional methods for teaching econometrics do not adequately prepare students to recognize biases to coefficient estimates;
- The high-level math and proofs are unnecessary and take valuable time away from more important concepts; and
- There are ethical problems in research, namely on the search for significance and not fully disclosing potential sources of bias.

#### 2.1. There Are Concerns on the Validity of Much Economic Research

#### 2.2. Biases in Coefficient Estimates Threaten a Model’s Validity More Than Biases in Standard Errors

#### 2.3. Current Methods Do Not Teach How to Recognize Biases

#### 2.4. The High-Level Math and Proofs Are Unnecessary and Take Valuable Time Away from More Important Concepts

#### 2.5. There Is an Ethical Problem in Economic Research

#### 2.6. What the Textbooks Teach

## 3. Research Topics with Decades of Research Errors

- (A)
- The hot hand in basketball, continuing the discussion from the Introduction;
- (B)
- The public-finance/macroeconomic topic of how state tax rates affect Gross State Product;
- (C)
- How occupation-specific bonuses affect the probability of reenlistment in the military.

#### 3.1. The Hot Hand in Basketball

#### 3.2. How State Income Tax Rates Affect Gross State Product

#### 3.3. How Occupation-Specific Bonuses Affect the Probability of Reenlistment

_{io}= β

_{1}× (BONUS)

_{io}+ X

_{io}β

_{2}+ µ

_{o}+ ε

_{io},

_{io}is the reenlistment/retention decision for serviceperson i in occupation o, BONUS is either a dollar amount or a multiple-of-basic-pay determining the amount a serviceperson would receive, X would be a set of other factors, such as year, home-state unemployment rate, and more, and µ

_{o}represents occupation fixed effects.

- There is the obvious bias of reverse causality in that lower reenlistment rates lead to higher bonuses.
- Enlisted personnel often have latitude on when they reenlist, so if they were planning to reenlist, they may time it to when the bonus appears to be higher than normal; so, the bonus is endogenous in that it is chosen to some extent by those reenlisting. This is an indirect reverse causality, in that the choice of reenlisting or not (R) would affect the timing of the reenlistment; and those choosing to reenlist would tend to do so when the bonus is relatively high within their reenlistment window.
- There is likely bias from measurement error, as servicepersons often have a few different bonuses during their reenlistment window, and the one most often recorded is the one at the official reenlistment date, not the one when they sign the new contract (which is not among the available data and can be up to two months earlier).
- There is unobserved heterogeneity because excess supply for reenlistments can mean that we only observe whether a person reenlists rather than whether he/she is willing to reenlist (or actual reenlistment supply). Excess supply of reenlistments could result from reduced demand from the military (e.g., occupations being eliminated) or worsening civilian prospects for the skill. Excess supply when an occupation is eliminated (and the reenlistment rate and bonus equals zero) could lead to a large exaggeration of the bonus effect.

#### 3.4. Summary

## 4. Recommended Changes and New Topics for Graduate Econometrics

- Replace the math with intuition and examples
- Focus on choosing the best set of control variables.

- A.
- Increase emphasis on some regression basics (“holding other factors constant” and regression objectives)
- B.
- Reduce emphasis on getting the standard errors correct
- C.
- Adopt new approaches for teaching how to recognize biases
- D.
- Shift focus to the more practical quasi-experimental methods
- E.
- Add emphasis on interpretations on statistical significance and p-values
- F.
- Advocate less complexity
- G.
- Add a simple ethical component

^{2}could be used as part of the “model selection criteria”. However, any measure of goodness-of-fit would primarily be useful for determining whether a variable should be included for forecasting/prediction. For estimating causal effects, whether a potential control variable contributes to explaining the dependent variable should not be a factor in determining whether it should be included in the model. These are just a few examples of why understanding the objective of the regression is important.

_{io}= β

_{1}× (BONUS)

_{io}+ X

_{io}β

_{2}+ µ

_{o}+ ε

_{io},

**A**, the average causal effect of the occupational-specific bonus on the probability that a serviceperson reenlists. We hope that $\widehat{{\beta}_{1}}$ is an unbiased estimate of

**A**in Figure 1. However, $\widehat{{\beta}_{1}}$ captures all the reasons why the bonus and the retention decision might move together (or not), after adjusting for the factors in X.

**B**in Figure 1. It very likely could, as a decrease in the probability of reenlistment for people in a certain occupation (due perhaps to increases in civilian labor market demand for the skill or increases in the deployment rates for the occupation) would cause the military service to have to increase the bonus; and an increase in the probability of reenlistment would allow the service to reduce the bonus.

**B**is likely negative, there would be a negative bias from the reverse causality on the estimated effect of the bonus on the probability of reenlistment. This bias would cause $\widehat{{\beta}_{1}}$ to be lower than the value of

**A**in Figure 1. (It requires much deeper and more-convoluted thought to determine the sign of the bias from an argument based on conditional mean dependence of the error term.) Thus, we would have an alternative story for why the estimated effect of the bonus is what it is—i.e., alternative to the causal-effects story. Attempts to address this with fixed effects would need to make sure that within the fixed-effects group, there still would not be any potential reverse causality (or omitted-variables bias).

**C**< 0 and

**D**> 0. Thus, not adequately controlling for working conditions (and other things that could impact both the bonus and retention) for the occupation would lead to a negative omitted-variables bias for $\widehat{{\beta}_{1}}$ (the product of

**C**and

**D**in Figure 1 would be negative). These are perhaps the most common sources of bias, and they follow directly from such a figure. However, there are other sources of bias, such as measurement error, that need to be considered.

**A**is the true average effect of a one-percentage-point increase in the state unemployment rate on the probability of a teenager using marijuana.

**C**, without arrows, is indicative of an incidental correlation that does not have an underlying systematic relationship).

“If applied economists narrow the focus of their research and critical reading to various forms of pseudo-experimental, the profession loses a good part of its ability to provide advice about the effects and uncertainties surrounding policy issues”.

- (1)
- As described above in some things I had missed in my own research, bias from measurement error can be exacerbated by fixed effects;
- (2)
- The estimated treatment effect with fixed effects is a weighted average of the estimated treatment effects within each fixed-effects group;
- (3)
- The natural regression weights of the fixed-effects groups with a higher variance of the treatment are disproportionately higher—this concept and the correction is described in Gibbons et al. (2018) and Arkes (2019, Section 8.3); and so shifting the natural weight of a group could partly explain why fixed-effects estimates are different from the corresponding estimates without fixed effects; also besides fixed effects, this concept applies to cases in which one simply controls for categories (e.g., race). Reweighting observations can help address this problem.

## 5. Implications for Undergraduate Econometrics

- replace the math with examples, which is a basic tenet of fostering student motivation (Ambrose et al. 2010)
- increase the emphasis on choosing the correct set of control variables.

## 6. Conclusions and Topics for Further Discussion

## Funding

## Acknowledgments

## Conflicts of Interest

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1 | See https://www.youtube.com/watch?v=BNHjX_08FE0. One extra 3-pointer he made came after a referee whistle, so he was actually (but not officially) 10 of 10. This performance harkens back to a game in which Boston Celtic Larry Bird hit every low-probability shot he put up, as he racked up 60 points against the Atlanta Hawks in 1985—https://www.youtube.com/watch?v=yX61Aurz3VM. (The best part of the video is the reaction by the Hawks’ bench to some of Bird’s last shots—those opponents knew Bird had the “hot hand”). |

2 | The new source of bias on improper reference groups is available under the “eResources” tab at https://www.routledge.com/Regression-Analysis-A-Practical-Introduction-1st-Edition/Arkes/p/book/9781138541405 or at https://tinyurl.com/yytmnq65. |

3 | |

4 |

Goldberger and Goldberger (1991) | Hayashi (2000) | Russell and MacKinnon (2004) | Angrist and Pischke (2009) | Greene (2012) | Wooldridge (2012) | |
---|---|---|---|---|---|---|

Causes of bias in the standard errors | ||||||

Heteroskedasticity | 0 | 10 | 11 | 2 | 2 | 8 |

Multicollinearity | 7 | 0 | 1 | 0 | 2 | 0 |

Causes of bias in the coefficient estimates | ||||||

Simultaneity | 6 | 3 | 13 | 0 | 22 | 32 |

Omitted-variables bias | 1 | 1 | 0 | 4 | 1 | 1 |

Measurement error | 0 | 3 | 2 | 1 | 2 | 6 |

Mediating factors | 0 | 0 | 0 | 4 | 0 | 0 |

Other important topics | ||||||

Holding other factors constant | 0 | 1 | 0 | 0 | 0 | 0 |

Fixed effects | 0 | 23 | 5 | 12 | 12 | 9 |

Bayesian critique of p-values | 0 | 0 | 0 | 0 | 0 | 0 |

Correctly indicates an insignificant coef. estimate does not mean accept the null | No | No | Yes | N/A | No | N/A |

Kennedy (2008) | Gujarati and Porter (2009) | Studenmund (2010) | Baltagi (2011) | Wooldridge (2015) | Angrist and Pischke (2015) | Dougherty (2016) | Stock and Watson (2018) | |
---|---|---|---|---|---|---|---|---|

Causes of bias in the standard errors | ||||||||

Heteroskedasticity | 5 | 47 | 1 | 12 | 28 | 1 | 17 | 5 |

Multicollinearity | 10 | 31 | 28 | 3 | 5 | 0 | 9 | 3 |

Causes of bias in the coefficient estimates | ||||||||

Simultaneity | 18 | 32 | 27 | 24 | 20 | 0 | 4 | 4 |

Omitted-variables bias | 2 | 6 | 8 | 0 | 5 | 13 | 9 | 9 |

Measurement error | 7 | 5 | 4 | 1 | 7 | 9 | 7 | 3 |

Mediating factors | 0 | 0 | 0 | 0 | 0 | 4 | 0 | 0 |

Other important topics | ||||||||

Holding other factors constant | 2 | 5 | 5 | 2 | 9 | 11 | 2 | 1 |

Fixed effects | 6 | 15 | 0 | 3 | 8 | 0 | 6 | 12 |

Bayesian critique of p-values | 19 | 0 | 0 | 0 | 0 | 0 | 0 | 0 |

Correctly indicates an insignificant coef. estimate does not mean accept the null | N/A | Yes | Yes (in a footnote) | N/A | Yes | N/A | Yes | N/A |

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## Share and Cite

**MDPI and ACS Style**

Arkes, J. Teaching Graduate (and Undergraduate) Econometrics: Some Sensible Shifts to Improve Efficiency, Effectiveness, and Usefulness. *Econometrics* **2020**, *8*, 36.
https://doi.org/10.3390/econometrics8030036

**AMA Style**

Arkes J. Teaching Graduate (and Undergraduate) Econometrics: Some Sensible Shifts to Improve Efficiency, Effectiveness, and Usefulness. *Econometrics*. 2020; 8(3):36.
https://doi.org/10.3390/econometrics8030036

**Chicago/Turabian Style**

Arkes, Jeremy. 2020. "Teaching Graduate (and Undergraduate) Econometrics: Some Sensible Shifts to Improve Efficiency, Effectiveness, and Usefulness" *Econometrics* 8, no. 3: 36.
https://doi.org/10.3390/econometrics8030036