The internal auditor of a bank has developed a multiple
regression model which has been used for a number of years to
estimate the amount of interes... Accounting MCQs | Accounting MCQs

The internal auditor of a bank has developed a multiple
regression model which has been used for a number of years 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 are justified by the change?

Changing to a cross-sectional regression analysis
should cause r2 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.Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

(c) The requirement is to provide an explanation for a
drop in r2. The coefficient of determination (r2) provides a
measure of amount of variation in the dependent variable (interest
income) explained by the independent variables. If there is a
dramatic decrease in the coefficient of determination, the implication
is that there are some new factors that are causing interest
income to change. Therefore, answer (c) is correct. Answer (a)
is incorrect because cross-sectional regression is not appropriate.
Management is attempting to estimate interest income over time.
Answer (b) is incorrect because regression analysis may still be
appropriate. Answer (d) is incorrect because multiple regression
is a linear model. Management may want to try other models
such as nonlinear multiple regression.