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Size and power of tests based on Permanent-Transitory Component Models

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  • Casalin, Fabrizio

Abstract

The literature has recently proposed a new type of tests for the Efficient Market Hypothesis based on Permanent-Transitory Component Models. We compare the power of these statistics with conventional tests based on linear regressions. Simulation results suggest that the former dominate the latter for a wide range of data generating processes. We propose an application to spot and forward interest rates. Empirical results show that the two types of tests can yield conflicting results which can be explained by the size distortions and reduced power which affect the statistics based on linear regressions.

Suggested Citation

  • Casalin, Fabrizio, 2016. "Size and power of tests based on Permanent-Transitory Component Models," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 142-153.
    • Handle: RePEc:eee:finana:v:47:y:2016:i:c:p:142-153
    DOI: 10.1016/j.irfa.2016.07.003
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    References listed on IDEAS

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    More about this item

    Keywords

    Efficient Markets Hypothesis; Permanent-Transitory Component Models; MC simulations;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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