The internal auditor of a bank has developed a multiple regression model which has been used for a number of gears to estimate the amount of interest income from commercial loans.
During the current year, the auditor applies the model and discovers that the r2 value has decreased dramatically, but the model otherwise seems to be working okay.
Which of the following conclusions is justified by the change?
- Changing to a cross-sectional regression analysis should cause r- to increase.
- Regression analysis is no longer an appropriate technique to estimate interest income.
- Some new factors not included in the model are causing interest income to change.
- A linear regression analysis would increase the model's reliability.
Answer(s): C
Explanation:
The coefficient of determination r-) is the amount of variation in the dependent variable interest income) that is explained by the independent variables. In this case, less of the change in interest income is explained by the model. Thus, some other factor must be causing interest income to change. This change merits audit investigation. In preparing the annual profit plan for the coming year, Wilkens Company wants to determine the cost behavior pattern of the maintenance costs. Wilkens has decided to use linear regression by employing the equation = a + bx for maintenance costs. The prior year's data regarding maintenance hours and costs, and the results of the regression analysis, are given below and in the opposite column.