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A Robust Test for Monotonicity in Asset Returns

Author

Listed:
  • Taufemback Cleiton G.

    (Institute of Mathematics and Statistics, Universidade Federal do Rio Grande do Sul, Porto Alegre 90040-060, Brazil)

  • Troster Victor

    (Department of Applied Economics, Universitat de les Illes Balears, Palma de Mallorca 07122, Spain)

  • Shahbaz Muhammad

    (Center for Energy and Environmental Policy Research, Beijing Institute of Technology, Beijing 100081, China)

Abstract

In this paper, we propose a robust test of monotonicity in asset returns that is valid under a general setting. We develop a test that allows for dependent data and is robust to conditional heteroskedasticity or heavy-tailed distributions of return differentials. Many postulated theories in economics and finance assume monotonic relationships between expected asset returns and certain underlying characteristics of an asset. Existing tests in literature fail to control the probability of a type 1 error or have low power under heavy-tailed distributions of return differentials. Monte Carlo simulations illustrate that our test statistic has a correct empirical size under all data-generating processes together with a similar power to other tests. Conversely, alternative tests are nonconservative under conditional heteroskedasticity or heavy-tailed distributions of return differentials. We also present an empirical application on the monotonicity of returns on various portfolios sorts that highlights the usefulness of our approach.

Suggested Citation

  • Taufemback Cleiton G. & Troster Victor & Shahbaz Muhammad, 2022. "A Robust Test for Monotonicity in Asset Returns," Journal of Time Series Econometrics, De Gruyter, vol. 14(1), pages 1-24, January.
    • Handle: RePEc:bpj:jtsmet:v:14:y:2022:i:1:p:1-24:n:5
    DOI: 10.1515/jtse-2019-0068
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    More about this item

    Keywords

    monotonicity tests; expected asset returns; heavy-tailed distributions; sign test; portfolio sorts;
    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

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