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On Standard-Error-Decreasing Complementarity: Why Collinearity is Not the Whole Story

Author

Listed:
  • Bernd Hayo

    () (University of Marburg)

Abstract

There is a widespread belief among economists that adding additional variables to a regression model causes higher standard errors. This note shows that, in general, this belief is unfounded and that the impact of adding variables on coefficients’ standard errors is unclear. The concept of standard-error-decreasing complementarity is introduced, which works against the collinearity-induced increase in standard errors. How standard-error-decreasing complementarity works is illustrated with the help of a nontechnical heuristic, and, using an example based on artificial data, it is shown that the outcome of popular econometric approaches can be potentially misleading.

Suggested Citation

  • Bernd Hayo, 2017. "On Standard-Error-Decreasing Complementarity: Why Collinearity is Not the Whole Story," MAGKS Papers on Economics 201703, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  • Handle: RePEc:mar:magkse:201703
    as

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    File URL: https://www.uni-marburg.de/fb02/makro/forschung/magkspapers/paper_2017/03-2017_hayo.pdf
    File Function: First 201703
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    References listed on IDEAS

    as
    1. Jonah B. Gelbach, 2016. "When Do Covariates Matter? And Which Ones, and How Much?," Journal of Labor Economics, University of Chicago Press, vol. 34(2), pages 509-543.
    2. Leamer, Edward E, 1983. "Let's Take the Con Out of Econometrics," American Economic Review, American Economic Association, vol. 73(1), pages 31-43, March.
    3. Bernd Hayo, 1998. "Simplicity in econometric modelling: some methodological considerations," Journal of Economic Methodology, Taylor & Francis Journals, vol. 5(2), pages 247-261.
    4. Keuzenkamp, H.A. & McAleer, M., 1994. "Simplicity, scientific inference and econometric modelling," Discussion Paper 1994-56, Tilburg University, Center for Economic Research.
    5. Gilbert, Christopher L, 1989. "LSE and the British Approach to Time Series Econometrics," Oxford Economic Papers, Oxford University Press, vol. 41(1), pages 108-128, January.
    6. Gilbert, Christopher L, 1986. "Professor Hendry's Econometric Methodology," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 48(3), pages 283-307, August.
    7. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    8. Edward E. Leamer, 2010. "Tantalus on the Road to Asymptopia," Journal of Economic Perspectives, American Economic Association, vol. 24(2), pages 31-46, Spring.
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    Citations

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    Cited by:

    1. Bernd Hayo & Florian Neumeier, 2018. "Households’ Inflation Perceptions and Expectations: Survey Evidence from New Zealand," ifo Working Paper Series 255, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    2. Bernd Hayo & Florian Neumeier, 2018. "Households’ Inflation Perceptions and Expectations: Survey Evidence from New Zealand," MAGKS Papers on Economics 201805, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    3. Bernd Hayo & Florian Neumeier, 2017. "Explaining Central Bank Trust in an Inflation Targeting Country: The Case of the Reserve Bank of New Zealand," ifo Working Paper Series 236, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.

    More about this item

    Keywords

    Standard-error-decreasing complementarity; multivariate regression model; standard error; econometric methodology; multicollinearity; collinearity;

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • B4 - Schools of Economic Thought and Methodology - - Economic Methodology

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