Definition of econometrics

Econometrics is the art and science of using data to test various economic theories. More specifically, econometrics can be viewed as the use of mathematics and sophisticated statistical modelling to test economic or financial theories as well as forecast the effects of changes in economic or financial factors under various scenarios.

Although econometric techniques are widely used in economic and financial analyses by both financial practitioners and academics, there is not one generally accepted definition of the term.

Econometrics is an inter-disciplinary effort to understand economic and financial behaviour through the use of data, economic theory, mathematics, statistical methods, and other quantitative techniques.

**Example**

The Capital Asset Pricing Model (CAPM) is a financial theory developed in the 1960s and posits a linear relationship between the return on a firm's stock and the return on the market portfolio (i.e., the weighted average return on all marketable securities available to an investor). This theory can be tested using econometric techniques such as ordinary least squares (OLS) regression analysis in order to verify if indeed a firm’s stock returns can be explained by movements in the returns on a market portfolio.

In this case, the analyst must obtain data on the returns to the stock and the market portfolio, as well as define what should be the appropriate proxy for the market portfolio (e.g., the FTSE-100 Index or the S&P 500 index). Statistical software systems can then use these data to estimate an OLS regression and compute statistics which, in turn, can be examined by a quantitative analyst or economist to determine whether the CAPM theory is supported for this stock.[1]

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