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Attenuation, when your regressor is measured with noise

Asked at DE Shaw

The true model is y=βx+εy = \beta x^* + \varepsilon, but you cannot observe xx^* cleanly. You measure x=x+ux = x^* + u, where uu is independent measurement noise (independent of xx^* and ε\varepsilon). You regress yy on the noisy xx.

Derive what your estimated slope converges to, and describe the bias.

Show a hint

Same technique as omitted-variable bias: write the slope as Cov(x,y)/Var(x)\operatorname{Cov}(x, y)/\operatorname{Var}(x) and substitute. The noise inflates the denominator but not the numerator.

Your answer

This one is open-ended. Work it through, then check your reasoning against the full solution.

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