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Testing for monotonicity in expected asset returns

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  • Romano, Joseph P.
  • Wolf, Michael

Abstract

Many postulated relations in finance imply that expected asset returns strictly increase in an underlying characteristic. To examine the validity of such a claim, one needs to take the entire range of the characteristic into account, as is done in the recent proposal of Patton and Timmermann (2010). But their test is only a test for the direction of monotonicity, since it requires the relation to be monotonic from the outset: either weakly decreasing under the null or strictly increasing under the alternative. When the relation is non-monotonic or weakly increasing, the test can break down and falsely ‘establish’ a strictly increasing relation with high probability. We offer some alternative tests that do not share this problem. The behavior of the various tests is illustrated via Monte Carlo studies. We also present empirical applications to real data.

Suggested Citation

  • Romano, Joseph P. & Wolf, Michael, 2013. "Testing for monotonicity in expected asset returns," Journal of Empirical Finance, Elsevier, vol. 23(C), pages 93-116.
    • Handle: RePEc:eee:empfin:v:23:y:2013:i:c:p:93-116
    DOI: 10.1016/j.jempfin.2013.05.001
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    References listed on IDEAS

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    1. Joseph P. Romano & Michael Wolf, 2005. "Stepwise Multiple Testing as Formalized Data Snooping," Econometrica, Econometric Society, vol. 73(4), pages 1237-1282, July.
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    5. Patton, Andrew J. & Timmermann, Allan, 2010. "Monotonicity in asset returns: New tests with applications to the term structure, the CAPM, and portfolio sorts," Journal of Financial Economics, Elsevier, vol. 98(3), pages 605-625, December.
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    Cited by:

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    2. Graham Elliott & Nikolay Kudrin & Kaspar Wüthrich, 2022. "Detecting p‐Hacking," Econometrica, Econometric Society, vol. 90(2), pages 887-906, March.
    3. Söhnke M. Bartram & Harald Lohre & Peter F. Pope & Ananthalakshmi Ranganathan, 2021. "Navigating the factor zoo around the world: an institutional investor perspective," Journal of Business Economics, Springer, vol. 91(5), pages 655-703, July.
    4. Ivan A. Canay & Azeem M. Shaikh, 2016. "Practical and theoretical advances in inference for partially identified models," CeMMAP working papers 05/16, Institute for Fiscal Studies.
    5. Guillaume Coqueret & Tony Guida, 2020. "Training trees on tails with applications to portfolio choice," Annals of Operations Research, Springer, vol. 288(1), pages 181-221, May.
    6. Matias D. Cattaneo & Richard K. Crump & Max H. Farrell & Ernst Schaumburg, 2020. "Characteristic-Sorted Portfolios: Estimation and Inference," The Review of Economics and Statistics, MIT Press, vol. 102(3), pages 531-551, July.
    7. Guillaume Coqueret & Tony Guida, 2020. "Training trees on tails with applications to portfolio choice," Post-Print hal-04144665, HAL.

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    More about this item

    Keywords

    Bootstrap; CAPM; Monotonicity tests; Non-monotonic relations;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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