Seminar 217, Risk Management: The Ratio Problem
Seminar | November 19 | 11 a.m.-12:30 p.m. | 1011 Evans Hall
Speaker: Frank Partnoy, UC Berkeley
ABSTRACT: We describe two problems omitted variable bias and measurement error that arise when a ratio is the dependent variable in a linear regression. First, we show how bias can arise from the omission of two variables based on a ratios denominator, and we describe tests for the degree of bias. As an example, we show that the familiar inverse U relationship between managerial ownership and Tobins Q is reversed when omitted variables are included. Second, we show how measurement error in the ratio denominator can lead to bias. We urge caution about using ratios as dependent variables.