1. Why is it desirable to remove insignificant variables from a regression?
2. Explain why it is not possible to include an outlier dummy variable in a regression model when you are conducting a Chow test for parameter stability. Will the same problem arise if you were to conduct a predictive failure test? Why or why not?
3. Re-open the ‘macro.wf1’ and apply the stepwise procedure including all of the explanatory variables as listed above, i.e. ersandp dprod dcredit dinflation dmoney dspread rterm with a strict 5% threshold criterion for inclusion in the model. Then examine the resulting model both financially and statistically by investigating the signs, sizes and significances of the parameter estimates and by conducting all of the
diagnostic tests for model adequacy.