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Converting true returns into reported returns: A general theory of linear smoothing and anti-smoothing

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  • McKenzie, Michael
  • Satchell, Stephen
  • Wongwachara, Warapong

Abstract

In this paper, we present a unified theory of linear smoothing, which looks at the problem from a time-series perspective. We use the term ‘conversion’ to refer to generic operations that create a difference between true returns and reported returns. ‘Smoothing’ occurs when that conversion process leads to a reduction in the variance of the reported returns and we establish the conditions which guarantee smoothing. Most importantly, we discuss situations where ‘anti-smoothing’ can occur, i.e. reported returns become more volatile than their true counterparts. Finally, we present empirical evidence of the presence of both smoothing and anti-smoothing in returns data for a number of different classes of asset.

Suggested Citation

  • McKenzie, Michael & Satchell, Stephen & Wongwachara, Warapong, 2014. "Converting true returns into reported returns: A general theory of linear smoothing and anti-smoothing," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 215-229.
  • Handle: RePEc:eee:empfin:v:28:y:2014:i:c:p:215-229
    DOI: 10.1016/j.jempfin.2014.07.003
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    More about this item

    Keywords

    Smoothing; Anti-smoothing; Appraisal; Time series; Alternative asset returns;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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