Regression Analysis — Dummy Variables
When an independent variable is nonmetric (e.g., seasonality), and has k (two or more) categories, it can be represented by k-1 dummy variables.
For example, the coding of in-store causal influences like display and co-op advertising can be captured with the use 3 dummy variables:
- Display only. (No co-op): D1=1, D2=D3=0.
- Co-op, no display: D2=1, D1=D3=0.
- Display + co-op: D3=1, D1=D2=0.
- The 4th option, no display and no co-op, is represented by D1=D2=D3=0.
The impact of dummy variables is reflected in the change of intercept (b0). For instance, consider the relationship between sales and discount price. The x-coefficient (b1 = discount price elasticity) remains unchanged when there is a display. The impact of an in-store display is reflected in an incremental lift in sales, referred to as uplift.
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