tailwind-nextjs-blog/data/blog/deriving-ols-estimator.mdx

---
title: Deriving the OLS Estimator
date: '2020-12-21'
tags: ['next js', 'math', 'ols']
draft: false
summary: 'How to derive the OLS Estimator with matrix notation and a tour of math typesetting using markdown with the help of KaTeX.'
---

# Introduction

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KaTeX and its associated font is included in `_document.js` so feel free to use it on any page.
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Inline math symbols can be included by enclosing the term between the `$` symbol.

Math code blocks are denoted by `$$`.

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[^2]: \$10 and $20.

# Deriving the OLS Estimator

Using matrix notation, let $n$ denote the number of observations and $k$ denote the number of regressors.

The vector of outcome variables $\mathbf{Y}$ is a $n \times 1$ matrix,

```tex
\mathbf{Y} = \left[\begin{array}
  {c}
  y_1 \\
  . \\
  . \\
  . \\
  y_n
\end{array}\right]
```

$$
\mathbf{Y} = \left[\begin{array}
  {c}
  y_1 \\
  . \\
  . \\
  . \\
  y_n
\end{array}\right]
$$

The matrix of regressors $\mathbf{X}$ is a $n \times k$ matrix (or each row is a $k \times 1$ vector),

```latex
\mathbf{X} = \left[\begin{array}
  {ccccc}
  x_{11} & . & . & . & x_{1k} \\
  . & . & . & . & .  \\
  . & . & . & . & .  \\
  . & . & . & . & .  \\
  x_{n1} & . & . & . & x_{nn}
\end{array}\right] =
\left[\begin{array}
  {c}
  \mathbf{x}'_1 \\
  . \\
  . \\
  . \\
  \mathbf{x}'_n
\end{array}\right]
```

$$
\mathbf{X} = \left[\begin{array}
  {ccccc}
  x_{11} & . & . & . & x_{1k} \\
  . & . & . & . & .  \\
  . & . & . & . & .  \\
  . & . & . & . & .  \\
  x_{n1} & . & . & . & x_{nn}
\end{array}\right] =
\left[\begin{array}
  {c}
  \mathbf{x}'_1 \\
  . \\
  . \\
  . \\
  \mathbf{x}'_n
\end{array}\right]
$$

The vector of error terms $\mathbf{U}$ is also a $n \times 1$ matrix.

At times it might be easier to use vector notation. For consistency, I will use the bold small x to denote a vector and capital letters to denote a matrix. Single observations are denoted by the subscript.

## Least Squares

**Start**:  
$$y_i = \mathbf{x}'_i \beta + u_i$$

**Assumptions**:

1. Linearity (given above)
2. $E(\mathbf{U}|\mathbf{X}) = 0$ (conditional independence)
3. rank($\mathbf{X}$) = $k$ (no multi-collinearity i.e. full rank)
4. $Var(\mathbf{U}|\mathbf{X}) = \sigma^2 I_n$ (Homoskedascity)

**Aim**:  
Find $\beta$ that minimises the sum of squared errors:

$$
Q = \sum_{i=1}^{n}{u_i^2} = \sum_{i=1}^{n}{(y_i - \mathbf{x}'_i\beta)^2} = (Y-X\beta)'(Y-X\beta)
$$

**Solution**:  
Hints: $Q$ is a $1 \times 1$ scalar, by symmetry $\frac{\partial b'Ab}{\partial b} = 2Ab$.

Take matrix derivative w.r.t $\beta$:

```tex
\begin{aligned}
  \min Q           & = \min_{\beta} \mathbf{Y}'\mathbf{Y} - 2\beta'\mathbf{X}'\mathbf{Y} +
  \beta'\mathbf{X}'\mathbf{X}\beta \\
                   & = \min_{\beta} - 2\beta'\mathbf{X}'\mathbf{Y} + \beta'\mathbf{X}'\mathbf{X}\beta \\
  \text{[FOC]}~~~0 & =  - 2\mathbf{X}'\mathbf{Y} + 2\mathbf{X}'\mathbf{X}\hat{\beta}                  \\
  \hat{\beta}      & = (\mathbf{X}'\mathbf{X})^{-1}\mathbf{X}'\mathbf{Y}                              \\
                   & = (\sum^{n} \mathbf{x}_i \mathbf{x}'_i)^{-1} \sum^{n} \mathbf{x}_i y_i
\end{aligned}
```

$$
\begin{aligned}
  \min Q           & = \min_{\beta} \mathbf{Y}'\mathbf{Y} - 2\beta'\mathbf{X}'\mathbf{Y} +
  \beta'\mathbf{X}'\mathbf{X}\beta \\
                   & = \min_{\beta} - 2\beta'\mathbf{X}'\mathbf{Y} + \beta'\mathbf{X}'\mathbf{X}\beta \\
  \text{[FOC]}~~~0 & =  - 2\mathbf{X}'\mathbf{Y} + 2\mathbf{X}'\mathbf{X}\hat{\beta}                  \\
  \hat{\beta}      & = (\mathbf{X}'\mathbf{X})^{-1}\mathbf{X}'\mathbf{Y}                              \\
                   & = (\sum^{n} \mathbf{x}_i \mathbf{x}'_i)^{-1} \sum^{n} \mathbf{x}_i y_i
\end{aligned}
$$