Question: Consider the two-equation system y1 = 1x1 + 1, y2 = 2x2 + 3x3 + 2. Assume that the disturbance variances and covariance are known.

Consider the two-equation system y1 = β1x1 + ε1, y2 = β2x2 + β3x3 + ε2. Assume that the disturbance variances and covariance are known. Now suppose that the analyst of this model applies GLS but erroneously omits x3 from the second equation. What effect does this specification error have on the consistency of the estimator of β1?

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The algebraic result is a little tedious but straightforward The GLS estimator which is computed is ... View full answer

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