INTRODUCTION TO ECONOMETRICS II ECO 306 NOUN 108 If more than one function gives rise to a significant estimate of
, that with the best fit maybe a guide to the nature of the heteroscedasticity. 3.1.3.6 Solution to Heteroscedasticity Problem Suppose that the true relationship is
…[3.04] Let the standard deviation of the disturbance term in observation ibe i u . If you happened to now i u for each observation, you could eliminate the heteroscedasticity by dividing each observation by its value of . The model becomes
i u
i u
i u i u i u …[3.05] The disturbance term i u i u becomes homoscedastic because the population variance of i i u is {( i u i u ) } 2 i u (
) 2 i u 2 i u …[3.06] That is, every observation will have a disturbance term drawn from a distribution with population variance 1, and the model will be homoscedastic. The revised model maybe rewritten as ' ' ' 1 2 i i i i Y h X u
…[3.07] where ' i i i u Y Y , ' i i i u X X , his anew variable whose value in observation iis 1 i u and ' i i i u u u
