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Long Memory Regressors and Predictive Testing: A Two-stage Rebalancing Approach

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  • Alex Maynard
  • Aaron Smallwood
  • Mark E. Wohar

Abstract

Predictability tests with long memory regressors may entail both size distortion and incompatibility between the orders of integration of the dependent and independent variables. Addressing both problems simultaneously, this paper proposes a two-step procedure that rebalances the predictive regression by fractionally differencing the predictor based on a first-stage estimation of the memory parameter. Extensive simulations indicate that our procedure has good size, is robust to estimation error in the first stage, and can yield improved power over cases in which an integer order is assumed for the regressor. We also extend our approach beyond the standard predictive regression context to cases in which the dependent variable is also fractionally integrated, but not cointegrated with the regressor. We use our procedure to provide a valid test of forward rate unbiasedness that allows for a long memory forward premium.

Suggested Citation

  • Alex Maynard & Aaron Smallwood & Mark E. Wohar, 2013. "Long Memory Regressors and Predictive Testing: A Two-stage Rebalancing Approach," Econometric Reviews, Taylor & Francis Journals, vol. 32(3), pages 318-360, November.
  • Handle: RePEc:taf:emetrv:v:32:y:2013:i:3:p:318-360
    DOI: 10.1080/07474938.2012.690663
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    Citations

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    Cited by:

    1. Hualde, Javier, 2014. "Estimation of long-run parameters in unbalanced cointegration," Journal of Econometrics, Elsevier, vol. 178(2), pages 761-778.
    2. repec:eee:intfin:v:48:y:2017:i:c:p:82-98 is not listed on IDEAS
    3. de Truchis, Gilles & Dell’Eva, Cyril & Keddad, Benjamin, 2017. "On exchange rate comovements: New evidence from a Taylor rule fundamentals model with adaptive learning," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 48(C), pages 82-98.
    4. Torben G. Andersen & Rasmus T. Varneskov, 2702. "Consistent Inference for Predictive Regressions in Persistent VAR Economies," CREATES Research Papers 2018-09, Department of Economics and Business Economics, Aarhus University.
    5. Daniela Osterrieder & Daniel Ventosa-Santaulària & J. Eduardo Vera-Valdés, 2015. "Unbalanced Regressions and the Predictive Equation," CREATES Research Papers 2015-09, Department of Economics and Business Economics, Aarhus University.
    6. Narayan, Seema & Smyth, Russell, 2015. "The financial econometrics of price discovery and predictability," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 380-393.
    7. Kruse Robinson & Ventosa-Santaulària Daniel & Noriega Antonio E., 2017. "Changes in persistence, spurious regressions and the Fisher hypothesis," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 21(3), pages 1-28, June.
    8. Tim Bollerslev & Daniela Osterrieder & Natalia Sizova & George Tauchen, 2011. "Risk and Return: Long-Run Relationships, Fractional Cointegration, and Return Predictability," CREATES Research Papers 2011-51, Department of Economics and Business Economics, Aarhus University.

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