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On the estimation of the volatility-growth link

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  • Andrey LAUNOV

    ()
    (University of Mainz, CESifo, and UCL Louvain la Neuve (IRES))

  • Olaf POSCH

    ()
    (Aarhus University and CREATES, CESifo)

  • Klaus WÄLDE

    ()
    (University of Mainz, CESifo, Center for Structural Estimation, University of Bristol and UCL Louvain-la-Neuve (IRES))

Abstract

It is common practice to estimate the volatility-growth link by specifying a standard growth equation such that the variance of the error term appears as an explanatory variable in this growth equation. The variance in turn is modelled by a second equation. Hardly any of existing applications of this framework includes exogenous controls in this second variance equation. Our theoretical findings suggest that the absence of relevant explanatory variables in the variance equation leads to a biased and inconsistent estimate of the volatility-growth link. Our simulations show that this effect is large. Once the appropriate controls are included in the variance equation consistency is restored. In short, we suggest that the variance equation must include relevant control variables to estimate the volatility-growth link.

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Bibliographic Info

Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2012009.

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Length: 8
Date of creation: 30 Apr 2012
Date of revision:
Handle: RePEc:ctl:louvir:2012009

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Keywords: volatility and growth; growth regression; endogenous variance unbiased estimates;

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  1. Daron Acemoglu & Simon Johnson & James Robinson & Yunyong Thaicharoen, 2002. "Institutional Causes, Macroeconomic Symptoms: Volatility, Crises and Growth," NBER Working Papers 9124, National Bureau of Economic Research, Inc.
  2. Olaf Posch, 2008. "Explaining output volatility: The case of taxation," CREATES Research Papers 2008-04, School of Economics and Management, University of Aarhus.
  3. Natalia Ponomareva & Hajime Katayama, 2010. "Does the version of the Penn World Tables matter? An analysis of the relationship between growth and volatility," Canadian Journal of Economics, Canadian Economics Association, vol. 43(1), pages 152-179, February.
  4. Jonathan Temple, 1999. "The New Growth Evidence," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 112-156, March.
  5. John W. Dawson & Joseph P. Dejuan & John J. Seater & E. Frank Stephenson, 2001. "Economic information versus quality variation in cross-country data," Canadian Journal of Economics, Canadian Economics Association, vol. 34(4), pages 988-1009, November.
  6. Jeffrey Edwards & Benhua Yang, 2009. "An empirical refinement of the relationship between growth and volatility," Applied Economics, Taylor & Francis Journals, vol. 41(11), pages 1331-1343.
  7. Olaf Posch & Klaus Wälde, 2011. "On the link between volatility and growth," Journal of Economic Growth, Springer, vol. 16(4), pages 285-308, December.
  8. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
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