James Stock and Mark Watson suggest a quite different approach to heteroskedasticity. They state that “economic theory rarely gives any reason to believe that the errors are homoskedastic. It therefore is prudent to assume that the errors might be heteroskedastic unless you have compelling reasons to believe otherwise.” As a result, Stock and Watson automatically use HC standard errors without testing for heteroskedasticity. In fact, since they adjust every equation for heteroskedasticity, they don’t even list homoskedasticity as a Classical Assumption.

a. What do you think? Do you agree with Stock and Watson? Explain your reasoning.

b. If Stock and Watson are right, does this mean that we don’t need to learn about heteroskedasticity in the first place? Did you waste your time reading this chapter?