DP127 The Econometric Analysis of Risk Terms

Author(s): Adrian Pagan, Aman Ullah
Publication Date: September 1986
Keyword(s): ARCH, Errors-in-Variables, Exchange Rates, Instrumental Variables, Interest Rates, Risk
JEL(s): 131, 211, 212, 313, 431
Programme Areas: Applied Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=127

This paper provides a critical survey of the methods employed to model the effects of risk in econometric models. Most of the popular methods are shown to suffer from errors-in-variables bias, and an instrumental variable method is suggested to overcome this problem. The technique exploits the orthogonality conditions existing between the squared unanticipated variables and functions of variables making up the information set defining the anticipations. An alternative procedure used in the paper is to directly estimate the conditional variance (risk) by non-parametric estimators. Applications are made to foreign exchange markets, interest rates and unemployment/inflation risk relations.