On the Estimation of the Volatility-Growth Link
CREATES Research Paper 2012-21
12 Pages Posted: 8 Oct 2014 Last revised: 23 Sep 2019
Date Written: September 20, 2019
It is common practice to estimate the volatility-growth link by specifying a growth equation such that the variance of the error term appears as an explanatory variable. Hardly any of existing applications of this framework includes exogenous controls in the variance equation. We show that the absence of relevant explanatory variables in the variance equation is not innocuous, leading to an omitted variable problem with an biased and inconsistent estimate of the volatility-growth link. Our simulations suggest that this effect is large and should be addressed in the empirical work. Once the appropriate controls are included consistency is restored.
Keywords: Volatility and growth; Volatility-growth regression; Endogenous variance; Unbiased estimates
JEL Classification: E32; O47
Suggested Citation: Suggested Citation