Closely related to but conceptually very much different from regression analysis is correlation analysis, where the primary objective is to measure the strength or degree of linear association between two variables. The correlation coefficient, which we shall study in detail in Chapter 3, measures this strength of (linear) association. For example, we may be interested in finding the correlation (coefficient) between smoking and lung cancer, between scores on statistics and mathematics examinations, between high school grades and college grades, and so on. In regression analysis, as already noted, we are not primarily interested in such a measure. Instead, we try to estimate or predict the average value of one variable on the basis of the fixed values of other variables. Thus, we may want to know whether we can predict the average score on a statistics examination by knowing a student's score on a mathematics examination.

Regression and correlation have some fundamental differences that are worth mentioning. In regression analysis there is an asymmetry in the way the dependent and explanatory variables are treated. The dependent variable is assumed to be statistical, random, or stochastic, that is, to have a probability distribution. The explanatory variables, on the other hand, are assumed to have fixed values (in repeated sampling),7 which was made explicit in the definition of regression given in Section 1.2. Thus, in Figure 1.2 we assumed that the variable age was fixed at given levels and height measurements were obtained at these levels. In correlation analysis, on the

5M. G. Kendall and A. Stuart, The Advanced Theory of Statistics, Charles Griffin Publishers, New York, 1961, vol. 2, chap. 26, p. 279.

6But as we shall see in Chap. 3, classical regression analysis is based on the assumption that the model used in the analysis is the correct model. Therefore, the direction of causality may be implicit in the model postulated.

7It is crucial to note that the explanatory variables may be intrinsically stochastic, but for the purpose of regression analysis we assume that their values are fixed in repeated sampling (that is, X assumes the same values in various samples), thus rendering them in effect non-random or nonstochastic. But more on this in Chap. 3, Sec. 3.2.

24 PART ONE: SINGLE-EQUATION REGRESSION MODELS

other hand, we treat any (two) variables symmetrically; there is no distinction between the dependent and explanatory variables. After all, the correlation between scores on mathematics and statistics examinations is the same as that between scores on statistics and mathematics examinations. Moreover, both variables are assumed to be random. As we shall see, most of the correlation theory is based on the assumption of randomness of variables, whereas most of the regression theory to be expounded in this book is conditional upon the assumption that the dependent variable is stochastic but the explanatory variables are fixed or nonstochastic.8

Before we proceed to a formal analysis of regression theory, let us dwell briefly on the matter of terminology and notation. In the literature the terms dependent variable and explanatory variable are described variously. A representative list is:

Although it is a matter of personal taste and tradition, in this text we will use the dependent variable/explanatory variable or the more neutral, regressand and regressor terminology.

If we are studying the dependence of a variable on only a single explanatory variable, such as that of consumption expenditure on real income, such a study is known as simple, or two-variable, regression analysis. However, if we are studying the dependence of one variable on more than

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