Binary Choice Model
1. When a decision maker has to choose between two mutually exclusive outcomes an
econometrician may choose to use a(n)
a) binary choice model
b) ECM
c) random effects model
d) fixed effects model
2. Which of the following is not a problem with the linear probability model?
a) assumes constant marginal effects
b) generates predictions outside the (0,1) interval
c) heteroskedastic error term
d) coefficient estimates are biased
3. When should a probit model be used?
a) when you need a binary choice model that allows for varying marginal effects
b) when you need to model the heteroskedasticity in the linear probability model
c) to allow for endogenous regressors in a binary choice model
d) to allow for multiple explanatory variables in a binary choice model
4. How are choices predicted in a binary choice model?
1 𝑖𝑓 𝑝̂ ≥ .5
a) 𝑦̂ = {
0 𝑖𝑓 𝑝̂ < .5
1 𝑖𝑓 𝑝̂ ≥ 0
b) 𝑦̂ = {
0 𝑖𝑓 𝑝̂ < 0
c) 𝑦̂ = 𝑝̂
d) 𝑦̂ = 𝑝̂ (1 − 𝑝̂ )
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5. We design a model to explain the choice by homebuyers of fixed versus adjustable rate
mortgages. They use 78 observations from a bank in Baton Rouge, Louisiana, taken over
the period January 1983 to February 1984. ADJUST=1 if an adjustable mortgage is
chosen. The explanatory variables, are
FIXRATE= fixed interest rate;
MARGIN=the variable rate-the fixed rate;
YIELD=the ten-year Treasury rate less the one-year rate;
MATURITY=ratio of maturities on adjustable to fixed rates;
POINTS=ratio of points paid on an adjustable mortgage to those paid on a fixed rate
mortgage;
NETWORTH=borrower’s net worth.
The following table summarizes the estimated linear probability model (LPM) and Probit
models (standard errors are in parentheses below the estimated coefficients).
Dependent variable ADJUST
Independent variables LPM Probit
Constant -0.0708 -1.8772
(1.288) (4.1206)
FIXRATE 0.160 0.4987
(0.0822) (0.2625)
MARGIN -0.132 -0.4310
(0.0498) (0.1739)
YIELD -0.793 -2.3839
(0.3230) (1.0830)
MATURITY -0.0341 -0.0591
(0.1910) (0.6226)
POINTS -0.0887 -0.2999
(0.0711) (0.2414)
NETWORTH 0.0289 0.0838
(0.0118) (0.0378)
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a) Based on the estimation in LPM (second column), explain whether the sign of the
FIXRATE estimate consistent with expectation? How do you interpret the
coefficient 0.160 for the variable of FIXRATE?
b) For the estimation results based on the Probit model, are the estimated coefficients
statistically significant?
c) Using the Probit estimation output, estimate the probability of choosing an
adjustable rate mortgage when the sample is with FIXRATE=13.25,
MARGIN=2.292, YIELD=1.606, MATURITY=1.058, POINT=1.498,
NETWORTH=3.504
d) For both LPM and Probit models, calculate respectively, the marginal effect of an
increase in the variable MARGIN, with all explanatory variables fixed at their
values in c). Explain the meaning of this value in Probit model.
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