Error Term

What is an 'Error Term'

An error term is a variable in a statistical and/or mathematical model, which is created when the model does not fully represent the actual relationship between the independent variable(s) and the dependent variable. As a result of this incomplete relationship, the error term is the amount at which the equation may differ during empirical analysis.

The error term is also known as the "residual", or the "remainder" term.

BREAKING DOWN 'Error Term'

An error term essentially means that the model will not be completely accurate, and will result in differing results during real world applications. For example, assume there is a multiple linear regression function that takes the form:

Error Term



When the actual Y differs from the Y in the model during an empirical test, then the error term will not be equal to 0, which means there are other factors that influence Y.

RELATED TERMS
  1. Heteroskedastic

    A measure in statistics that refers to the variance of errors ...
  2. Error Of Principle

    An accounting mistake in which an entry is recorded in the incorrect ...
  3. Linear Relationship

    A statistical term used to describe the directly proportional ...
  4. Nonlinear Regression

    A form of regression analysis in which data is fit to a model ...
  5. Homoskedastic

    A statistics term indicating that the variance of the errors ...
  6. Endogenous Variable

    A classification of a variable generated by a statistical model ...
Related Articles
  1. Markets

    Understanding Regression

    Regression is a statistical analysis that attempts to predict the effect of one or more variables on another variable.
  2. ETFs & Mutual Funds

    3 Reasons Tracking Error Matters

    Discover three ways investors can use tracking error to measure performance for a mutual fund or ETF, whether indexed or actively managed.
  3. Investing

    Regression Basics For Business Analysis

    This tool is easy to use and can provide valuable information on financial analysis and forecasting. Find out how.
  4. Markets

    Explaining Linear Relationships

    A linear relationship describes the proportionality between an independent variable and a dependent variable.
  5. Investing

    10 Steps To Help Erase Errors On Your Credit Report

    According to a study conducted by the Federal Trade Commission, one in four consumers identified errors on their reports that might affect their credit rating in 2013.
  6. Personal Finance

    What Does Errors and Omissions Insurance Cover?

    Errors and omissions insurance protects companies and individuals against claims made by clients for inadequate work or negligent actions.
  7. ETFs & Mutual Funds

    How This New ETF Tracks Millennial Consumer Habits

    A recently launched ETF aims to track Millennial consumer habits.
  8. Investing

    The Basics Of Business Forecasting

    Discover the methods behind financial forecasts and the risks inherent when we seek to predict the future.
  9. Investing

    Understanding Financial Models

    A financial model is a representation of some aspects of a firm or given security. It uses historical numbers to create calculations that inform financial recommendations or predict future financial ...
  10. Markets

    Stock and Flow Variables Explained: A Closer Look at Apple

    The difference between stock and flow variables is an essential concept in finance and economics. We illustrate with financial statements from Apple Inc.
RELATED FAQS
  1. How is the standard error used in trading?

    Understand how the standard error is used in statistics and what it measures. Learn how the standard error is used in trading ... Read Answer >>
  2. What is a relative standard error?

    Find out how to distinguish between mean, standard deviation, standard error and relative standard error in statistical survey ... Read Answer >>
  3. What is the difference between linear regression and multiple regression?

    Learn the difference between linear regression and multiple regression and how multiple regression encompasses not only linear ... Read Answer >>
  4. How can I run linear regressions in MATLAB?

    Learn how to run linear regressions in MATLAB by loading data, specifying dependent and independent variables and using the ... Read Answer >>
  5. What is the difference between financial forecasting and financial modelling?

    Understand the difference between financial forecasting and financial modeling, and learn why a company should conduct both ... Read Answer >>
  6. How is the ability to perform Activities of Daily Living (ADL) measured?

    Find out how to apply sensitivity analysis to your investment decisions, why sensitivity analysis might be useful and what ... Read Answer >>
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center