Copyright © 2014, 2011 Pearson Education, Inc. 1 Chapter 22 Regression Diagnostics

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Although regression analysis allows the use of prices of different size homes to estimate the home of a specific size, prices tend to be more variable for larger homes. How does this affect the SRM?  Consider how to recognize and fix three potential problems affecting regression models: changing variation in the data, outliers, and dependence among observations

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Price ($000) vs. Home Size (Sq. Ft.) Both the average and standard deviation in price increase as home size increases.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation SRM Results: Home Price Example

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Fixed Costs, Marginal Costs, and Variable Costs  The estimated intercept (50.599) can be interpreted as the fixed cost of a home.  The 95% confidence interval for the intercept (after rounding) is -$4,000 to $105,000.  Since it includes zero, this interval is not a precise estimate of fixed costs.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Fixed Costs, Marginal Costs, and Variable Costs  The slope (0.159) estimates the marginal cost of an additional square foot of space.  The 95% confidence interval for the slope (after rounding) is $135,000 to $183,500.  It can be interpreted as the average difference in home price associated with 1,000 square feet.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Detecting Differences in Variation  Based on the scatterplot, the association between home price and size appears linear.  Little concern about lurking variables since the sample of homes is from the same neighborhood.  Similar variances condition is not satisfied.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Detecting Differences in Variation Fan-shaped appearance of residual plot indicates changing variances.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Detecting Differences in Variation Side-by-side boxplots confirm that variances increase as home size increases.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Detecting Differences in Variation  Heteroscedastic: errors that have different amounts of variation.  Homoscedastic: errors having equal amounts of variation.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Consequences of Different Variation  Prediction intervals are too narrow or too wide.  Confidence intervals for the slope and intercept are not reliable.  Hypothesis tests regarding β 0 and β 1 are not reliable.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Consequences of Different Variation The 95% prediction intervals are too wide for small homes and too narrow for large homes.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Fixing the Problem: Revise the Model  If F represents fixed cost and M marginal costs, the equation of the SRM becomes Price =

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Fixing the Problem: Revise the Model  Divide both sides of the equation by the number of square feet and simplify:

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Fixing the Problem: Revise the Model  The response variable becomes price per square foot and the explanatory variable becomes the reciprocal of the number of square feet.  The marginal cost M is the intercept and the slope is F, the fixed cost.  The residuals have similar variances.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Fixing the Problem: Revise the Model Boxplots confirm homoscedastic errors.

Copyright © 2014, 2011 Pearson Education, Inc. 17 4M Example 22.1: ESTIMATING HOME PRICES Motivation A company is relocating several managers to the Seattle area. For budgeting purposes, they would like a break down of home prices into fixed and variable costs to better prepare for negotiations with realtors.

Copyright © 2014, 2011 Pearson Education, Inc. 18 4M Example 22.1: ESTIMATING HOME PRICES Method Data consists of a sample of 94 homes for sale in Seattle. The explanatory variable is the reciprocal of home size and the response is price per square foot. The scatterplot shows a linear association and there are no obvious lurking variables.

Copyright © 2014, 2011 Pearson Education, Inc. 19 4M Example 22.1: ESTIMATING HOME PRICES Mechanics Evidently independent, similar variances, and nearly normal conditions met.

Copyright © 2014, 2011 Pearson Education, Inc. 20 4M Example 22.1: ESTIMATING HOME PRICES Mechanics The SRM results.

Copyright © 2014, 2011 Pearson Education, Inc. 21 4M Example 22.1: ESTIMATING HOME PRICES Mechanics The fitted equation is Estimated $/SqFt = ,887/SqFt. The 95% confidence interval for the intercept is [ to ] and the 95% confidence interval for the slope is [18,663 to 89,111].

Copyright © 2014, 2011 Pearson Education, Inc. 22 4M Example 22.1: ESTIMATING HOME PRICES Message Prices for homes in this Seattle neighborhood run about $140 to $180 per square foot, on average. Average fixed costs associated with the purchase are in the range $20,000 to $90,000, with 95% confidence.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Comparing Models with Different Responses Even though the revised model has a smaller r 2,  It provides more reliable and narrower confidence intervals for fixed and variable costs; and  It provides more sensible prediction intervals.

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Comparing Models with Different Responses

Copyright © 2014, 2011 Pearson Education, Inc Changing Variation Comparing Models with Different Responses

Copyright © 2014, 2011 Pearson Education, Inc Outliers Consider a Contractor’s Bid on a Project A contractor is bidding on a project to construct an 875 square-foot addition to a home.  If he bids too low, he loses money on the project.  If he bids too high, he does not get the job.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Contractor Data for n=30 Similar Projects Note that all but one of his previous projects are smaller than 875 square feet.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Contractor Example  His one project at 900 square feet is an outlier.  It is also a leveraged observation as it pulls the regression line in its direction.  Leveraged: an observation in regression that has a small or large value of the explanatory variable.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Consequences of an Outlier  To see the consequences of an outlier, fit the least squares regression line both with and without it.  Use the standard errors obtained without including the outlier to compare estimates.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Consequences for the Contractor Example

Copyright © 2014, 2011 Pearson Education, Inc Outliers Consequences for the Contractor Example  Including the outlier shifts the estimated fixed cost up by about 1.5 standard errors.  Including the outlier shifts the estimated marginal cost down by about 1.56 standard errors.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Consequences for the Contractor Example Prediction intervals when the outlier is included.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Consequences for the Contractor Example Prediction intervals when the outlier is not included.

Copyright © 2014, 2011 Pearson Education, Inc Outliers Fixing the Problem: More Information  If the outlier describes what is expected the next time under the same conditions, then it should be included.  In the contractor example, more information is needed to decide whether to include or exclude the outlier.

Copyright © 2014, 2011 Pearson Education, Inc Dependent Errors and Time Series Detecting Dependence  With time series data, plot residuals versus time to look for a pattern indicating dependence in the errors.  Use the Durbin-Watson statistic to test for correlation between adjacent residuals (known as autocorrelation).

Copyright © 2014, 2011 Pearson Education, Inc Dependent Errors and Time Series Detecting Dependence Scatterplot suggests few problems with fit.

Copyright © 2014, 2011 Pearson Education, Inc Dependent Errors and Time Series Detecting Dependence Timeplot of residuals from regression of change in employment on utilization reveals dependence.

Copyright © 2014, 2011 Pearson Education, Inc Dependent Errors and Time Series The Durbin-Watson Statistic  Tests the null hypothesis H 0 : ρ ε = 0.  Is calculated as follows:

Copyright © 2014, 2011 Pearson Education, Inc Dependent Errors and Time Series The Durbin-Watson Statistic  Use p-value provided by software or table of critical values at α = 0.05 (portion shown below) to draw a conclusion.

Copyright © 2014, 2011 Pearson Education, Inc Dependent Errors and Time Series Consequences of Dependence  If there is positive autocorrelation in the errors, the estimated standard errors are too small.  The estimated slope and intercept are less precise than suggested by the output.  Best remedy is to incorporate the dependence into the regression model.

Copyright © 2014, 2011 Pearson Education, Inc. 41 4M Example 22.2: CELL PHONE SUBSCRIBERS Motivation Predict the market for cellular telephone services.

Copyright © 2014, 2011 Pearson Education, Inc. 42 4M Example 22.2: CELL PHONE SUBSCRIBERS Method Use simple regression to predict the future number of subscribers. The number of subscriber connections, in millions, is the response. The explanatory variable is the date (time). The scatterplot shows a linear association. Lurking variables may be present, such as technology and marketing.

Copyright © 2014, 2011 Pearson Education, Inc. 43 4M Example 22.2: CELL PHONE SUBSCRIBERS Mechanics The least squares equation is Estimated Subscribers = - 40, Date

Copyright © 2014, 2011 Pearson Education, Inc. 44 4M Example 22.2: CELL PHONE SUBSCRIBERS Mechanics The timeplot of meandering residuals and D = 0.25 indicate independence condition is not satisfied.

Copyright © 2014, 2011 Pearson Education, Inc. 45 4M Example 22.2: CELL PHONE SUBSCRIBERS Message There is a strong upward trend in the number of subscribers that can be summarized by Estimated Subscribers = -40, Date. However, since the conditions for SRM are not satisfied, we cannot rely on statistical inferences to quantify the uncertainty for predictions.

Copyright © 2014, 2011 Pearson Education, Inc. 46 Best Practices  Make sure that your model makes sense.  Plan to change your model if it does not match the data.  Report the presence of and how you handle any outliers.

Copyright © 2014, 2011 Pearson Education, Inc. 47 Pitfalls  Do not rely on summary statistics like r 2 to pick the best model.  Don’t compare r 2 between regression models unless the response is the same.  Do not check for normality until you get the right equation.

Copyright © 2014, 2011 Pearson Education, Inc. 48 Pitfalls (Continued)  Don’t think that your data are independent if the Durbin-Watson statistic is close to 2.  Never forget to look at plots of the data and model.