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Unit-Root Test and Excess Returns

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Author Info
Godbout, M.J.
Van Norden, S.

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Abstract

Several recent papers have presented evidence from foreign exchange and other markets suggesting that the log of excess returns can be characterized as first-order integrated processes (I(1)). This contrasts sharply with the "conventional" wisdom that log prices are integrated of order one I(1) and that log returns should therefore be integrated of order zoro I(0), and even more sharply with the view that past returns have no ability to predict future returns (weak market efficiency). It has been suggested that this should be interpreted as evidence of the importance of regime- switching in asset prices, since such non linear processes can produce these results even when returns are truly I(0). This paper syggests an alternative interpretation.

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File URL: http://www.bankofcanada.ca/en/res/wp/1996/wp96-10.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 96-10.

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Length: 27 pages
Date of creation: 1996
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Handle: RePEc:bca:bocawp:96-10

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Related research
Keywords: FINANCIAL MARKET; UNIT ROOTS; PRICES;

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Gregory, Allan W, 1994. "Testing for Cointegration in Linear Quadratic Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 347-60, July.
    Other versions:
  2. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May. [Downloadable!] (restricted)
    Other versions:
  3. Hali J. Edison & Joseph E. Gagnon & William R. Melick, 1994. "Understanding the empirical literature on purchasing power parity: the post-Bretton Woods era," International Finance Discussion Papers 465, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  4. Steven N. Durlauf, 1989. "Output Persistence, Economic Structure, and the Choice of Stabilization Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1989-2), pages 69-136. [Downloadable!]
  5. Marie-Josée Godbout & Simon van Norden, 1997. "Reconsidering Cointegration in International Finance: Three Case Studies of Size Distortion in Finite Samples," Working Papers 97-1, Bank of Canada. [Downloadable!]
  6. Baillie, Richard T & Bollerslev, Tim, 1994. "The long memory of the forward premium," Journal of International Money and Finance, Elsevier, vol. 13(5), pages 565-571, October. [Downloadable!] (restricted)
    Other versions:
  7. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
  8. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 141-220 National Bureau of Economic Research, Inc. [Downloadable!]
    Other versions:
  9. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  10. Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
  11. Evans, Martin D D & Lewis, Karen K, 1995. "Do Long-Term Swings in the Dollar Affect Estimates of the Risk Premia?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(3), pages 709-42. [Downloadable!] (restricted)
    Other versions:
  12. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May. [Downloadable!] (restricted)
  13. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March. [Downloadable!] (restricted)
  14. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July. [Downloadable!] (restricted)
    Other versions:
  15. Bekaert, Geert & Hodrick, Robert J., 1993. "On biases in the measurement of foreign exchange risk premiums," Journal of International Money and Finance, Elsevier, vol. 12(2), pages 115-138, April. [Downloadable!] (restricted)
    Other versions:
  16. Evans, Martin D. D. & Lewis, Karen K., 1994. "Do stationary risk premia explain it all?: Evidence from the term structure," Journal of Monetary Economics, Elsevier, vol. 33(2), pages 285-318, April. [Downloadable!] (restricted)
    Other versions:
  17. Brenner, Robin J. & Kroner, Kenneth F., 1995. "Arbitrage, Cointegration, and Testing the Unbiasedness Hypothesis in Financial Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(01), pages 23-42, March. [Downloadable!]
  18. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  19. Baillie, Richard T & Bollerslev, Tim, 1989. " Common Stochastic Trends in a System of Exchange Rates," Journal of Finance, American Finance Association, vol. 44(1), pages 167-81, March. [Downloadable!] (restricted)
  20. Scott Hendry, 1995. "Long-Run Demand for M1," Macroeconomics 9511001, EconWPA. [Downloadable!]
  21. Toda, Hiro Y., 1995. "Finite Sample Performance of Likelihood Ratio Tests for Cointegrating Ranks in Vector Autoregressions," Econometric Theory, Cambridge University Press, vol. 11(05), pages 1015-1032, October. [Downloadable!]
  22. Martin D. Evans & Karen K. Lewis, 1992. "Trends in Excess Returns in Currency and Bond Markets," Working Papers 92-32, New York University, Leonard N. Stern School of Business, Department of Economics.
  23. GONZALOÊ, Jesus & PITARAKISÊ, Jean-Yves, 1994. "Comovements in Large Systems," CORE Discussion Papers 1994065, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  24. repec:cup:etheor:v:11:y:1995:i:5:p:1015-32 is not listed on IDEAS
  25. Crowder, William J, 1994. "Foreign exchange market efficiency and common stochastic trends," Journal of International Money and Finance, Elsevier, vol. 13(5), pages 551-564, October. [Downloadable!] (restricted)
  26. Gonzalo, Jesus, 1994. "Five alternative methods of estimating long-run equilibrium relationships," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 203-233. [Downloadable!] (restricted)
  27. Cochrane, John H., 1991. "A critique of the application of unit root tests," Journal of Economic Dynamics and Control, Elsevier, vol. 15(2), pages 275-284, April. [Downloadable!] (restricted)
  28. Gonzalo, J. & Lee, T.H., 1995. "Pitfalls in Testing for Long Run Relationships," Papers 38, Boston University - Department of Economics.
    Other versions:
  29. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254. [Downloadable!] (restricted)
  30. Evans, Martin D. D. & Lewis, Karen K., 1993. "Trends in excess returns in currency and bond markets," European Economic Review, Elsevier, vol. 37(5), pages 1005-1019, June. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Joseph Atta-Mensah, 2004. "Money Demand and Economic Uncertainty," Working Papers 04-25, Bank of Canada. [Downloadable!]
  2. Eric Zivot, 1998. "Cointegration and Forward and Spot Exchange Rate Regressions," Econometrics 9812001, EconWPA. [Downloadable!]
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