Using Dummy Variables to Represent Categorical Variables

6 Pages Posted: 21 Oct 2008

See all articles by Phillip E. Pfeifer

Phillip E. Pfeifer

University of Virginia - Darden School of Business

Abstract

The note introduces and explains 0-1 dummy variables and how they may be used to represent categorical independent variables in a regression model.

Excerpt

UVA-QA-0330

USING DUMMY VARIABLES TO REPRESENT

CATEGORICAL VARIABLES

In a number of practical business situations, an important explanatory variable is categorical rather than numerical. For instance, an MBA's starting salary may be related to his or her undergraduate degree program (liberal arts, business, science, or engineering). The sales of a consumer packaged good may be related to its position in the store (check-out register versus regular store rack). Or the price-to-earnings ratio of a stock may be related to the presence (absence) of a dividend (irrespective of the size of the dividend). In each of these examples, the potential explanatory variable is not numerically scaled and thus not directly usable as an independent X-variable in a linear model. This note describes and illustrates a technique (called dummy variables) for transforming categorical information into numerically scaled variables suitable for use in a linear model.

Example

An extensive questionnaire was administered to several auto workers in four U.S. assembly plants. The variable of interest, Y, was a weighted combination of responses to several questions measuring job satisfaction. Management wanted to compare the levels of reported job satisfaction at the four plants. A small subsample of the data from two plants is given in Table 1.

. . .

Keywords: quantitative analysis, general, regression analysis, statistics

Suggested Citation

Pfeifer, Phillip E., Using Dummy Variables to Represent Categorical Variables. Darden Case No. UVA-QA-0330, Available at SSRN: https://ssrn.com/abstract=1283385

Phillip E. Pfeifer (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4803 (Phone)

HOME PAGE: http://www.darden.virginia.edu/faculty/Pfeifer.htm

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