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A note on using ratio variables in regression analysis

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  • Lien, Donald
  • Hu, Yue
  • Liu, Long

Abstract

This paper revisits the problem of choosing ratio variables in regression analysis in Musumeci and Peterson (2011). In the application we examined, linear regressions with the ratio variable, its reciprocal or logarithm have been rejected. To avoid model misspecifications, we suggest to use nonlinear regressions on ratio variables. Our empirical evidence shows that a semiparametric partially linear model could be a robust solution. In particular, the logarithm of the ratio variable performs slightly better than the ratio variable and its reciprocal.

Suggested Citation

  • Lien, Donald & Hu, Yue & Liu, Long, 2017. "A note on using ratio variables in regression analysis," Economics Letters, Elsevier, vol. 150(C), pages 114-117.
    • Handle: RePEc:eee:ecolet:v:150:y:2017:i:c:p:114-117
    DOI: 10.1016/j.econlet.2016.11.019
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    More about this item

    Keywords

    Semiparametric regression; Partially linear model; Ratio variable; Market-to-book;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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