"Heteroskedasticity typically occurs in cross-sections, while serial correlation is typically observed in time-series data." Discuss and critically evaluate this statement

What will be an ideal response?


Answer: Serial correlation in cross-sections can occur by chance if the data is ordered using one of the regressors. While it is easy to get rid of serial correlation in this case by simply "reshuffling" the data, the serial correlation contains some information, such as a possible misspecification of functional form.

Serial correlation does occur typically in time-series data, but as the textbook emphasized, conditional heteroskedasticity "shows up in many economic time series." The ARCH and GARCH models are often used when volatility clustering is present in financial time series, including the inflation rate. Hence this special type of heteroskedasticity is observed in time-series data.

Economics

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