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Orthogonalized regressors and spurious precision

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  • Sercu, Piet
  • Vandebroek, Martina
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    Abstract

    The exposure of a stock's return to exchange-rate changes is conventionally estimated by regression. Often, the market return is included as an additional regressor. By first orthogonalizing the market return on the exchange rate one seems to have the best of both worlds: the market factor cannot subsume part of the exposure present in a stock's return, and these of the estimate beats both the simple -and the multiple- regression SE's. This last effect is illusory: since the simple and the pseudo-multiple regression always produce the same exposure estimate, given the sample, their precision must be identical too. Technically, the source of the problem is that the uncertainty about the market's exposure estimate is left out of the calculated SE. In published work, the calculated error variances should be corrected upward by 20 to 100 percent.

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    File URL: https://lirias.kuleuven.be/bitstream/123456789/120985/1/AFI_0618.pdf
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    Bibliographic Info

    Paper provided by Katholieke Universiteit Leuven in its series Open Access publications from Katholieke Universiteit Leuven with number urn:hdl:123456789/120985.

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    Date of creation: 2006
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    Handle: RePEc:ner:leuven:urn:hdl:123456789/120985

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    Web page: http://www.kuleuven.be

    Related research

    Keywords: Currency; Exchange; Exposure; Market; Market model; Multiple regression; Precision; Regression; Uncertainty; Variance; Work;

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    1. Arturo Bris & Yrj� Koskinen & Vicente Pons, 2004. "Corporate Financial Policies and Performance around Currency Crises," The Journal of Business, University of Chicago Press, vol. 77(4), pages 749-796, October.
    2. Horst Entorf & Jochen Moebert & Katja Sonderhof, 2011. "The Foreign Exchange Rate Exposure of Nations," Open Economies Review, Springer, vol. 22(2), pages 339-353, April.
    3. Entorf, Horst & Moebert, Jochen & Sonderhof, Katja, 2007. "The foreign exchange rate rate exposure of nations," ZEW Discussion Papers 07-005, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    4. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-84, June.
    5. Martin Glaum & Marko Brunner & Holger Himmel, 2000. "The DAX and the Dollar: The Economic Exchange Rate Exposure of German Corporations," Journal of International Business Studies, Palgrave Macmillan, vol. 31(4), pages 715-724, December.
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