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In-sample or out-of-sample tests of predictability: which one should we use?

  • Inoue, Atsushi
  • Kilian, Lutz

It is widely known that significant in-sample evidence of predictability does not garantuee significant out-of-sample predictability. This is often interpreted as an indiciation that in-sample evidence is likely to be spurious and should be discounted. In this paper we question this conventional wisdom. Our analysis shows that neither data mining nor parameter instability is a plausible explanation of the observed tendency of in-smaple tests to reject the no predictability null more often than out-of-sample tests. We provide an alternative explanation based on the higher power of in-sample tests of predictability. We conclude that results of in-sample tests of predictability will typically be more credible than results of out-of-sample tests. JEL Classification: C12, C22, C52

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Paper provided by European Central Bank in its series Working Paper Series with number 0195.

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Date of creation: Nov 2002
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Handle: RePEc:ecb:ecbwps:20020195
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