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Predictive regressions with panel data

  • Erik Hjalmarsson

This paper analyzes panel data inference in predictive regressions with endogenous and nearly persistent regressors. The standard fixed effects estimator is shown to suffer from a second order bias; analytical results, as well as Monte Carlo evidence, show that the bias and resulting size distortions can be severe. New estimators, based on recursive demeaning as well as direct bias correction, are proposed and methods for dealing with cross sectional dependence in the form of common factors are also developed. Overall, the results show that the econometric issues associated with predictive regressions when using time-series data to a large extent also carry over to the panel case. However, practical solutions are more readily available when using panel data. The results are illustrated with an application to predictability in international stock indices.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 869.

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Date of creation: 2006
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Handle: RePEc:fip:fedgif:869
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  1. Phillips, Peter C B & Hansen, Bruce E, 1990. "Statistical Inference in Instrumental Variables Regression with I(1) Processes," Review of Economic Studies, Wiley Blackwell, vol. 57(1), pages 99-125, January.
  2. Nelson, Charles R & Kim, Myung J, 1993. " Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-61, June.
  3. Polk, Christopher & Thompson, Samuel & Vuolteenaho, Tuomo, 2006. "Cross-sectional forecasts of the equity premium," Journal of Financial Economics, Elsevier, vol. 81(1), pages 101-141, July.
  4. Peter C.B. Phillips & Hyungsik R. Moon, 1999. "Linear Regression Limit Theory for Nonstationary Panel Data," Cowles Foundation Discussion Papers 1222, Cowles Foundation for Research in Economics, Yale University.
  5. Moon, Hyungsik R. & Phillips, Peter C.B., 1999. "Estimation of Autoregressive Roots near Unity using Panel Data," University of California at Santa Barbara, Economics Working Paper Series qt7fd8x80m, Department of Economics, UC Santa Barbara.
  6. M. Hashem Pesaran, 2004. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," CESifo Working Paper Series 1331, CESifo Group Munich.
  7. Michael Jansson & Marcelo J. Moreira, 2006. "Optimal Inference in Regression Models with Nearly Integrated Regressors," Econometrica, Econometric Society, vol. 74(3), pages 681-714, 05.
  8. Donald W. K. Andrews, 2005. "Cross-Section Regression with Common Shocks," Econometrica, Econometric Society, vol. 73(5), pages 1551-1585, 09.
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  10. Phillips, Peter C.B. & Sul, Donggyu, 2007. "Bias in dynamic panel estimation with fixed effects, incidental trends and cross section dependence," Journal of Econometrics, Elsevier, vol. 137(1), pages 162-188, March.
  11. Goetzmann, William Nelson & Jorion, Philippe, 1993. " Testing the Predictive Power of Dividend Yields," Journal of Finance, American Finance Association, vol. 48(2), pages 663-79, June.
  12. Graham Elliott, 1998. "On the Robustness of Cointegration Methods when Regressors Almost Have Unit Roots," Econometrica, Econometric Society, vol. 66(1), pages 149-158, January.
  13. Gregory Mankiw, N. & Shapiro, Matthew D., 1986. "Do we reject too often? : Small sample properties of tests of rational expectations models," Economics Letters, Elsevier, vol. 20(2), pages 139-145.
  14. Peter C.B. Phillips & Bruce E. Hansen, 1988. "Statistical Inference in Instrumental Variables," Cowles Foundation Discussion Papers 869R, Cowles Foundation for Research in Economics, Yale University, revised Apr 1989.
  15. Donggyu Sul & Peter C.B. Phillips & Choi, Chi-Young, 2003. "Prewhitening Bias in HAC Estimation," Cowles Foundation Discussion Papers 1436, Cowles Foundation for Research in Economics, Yale University.
  16. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research.
  17. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, vol. 74(2), pages 209-235, November.
  18. Cavanagh, Christopher L. & Elliott, Graham & Stock, James H., 1995. "Inference in Models with Nearly Integrated Regressors," Econometric Theory, Cambridge University Press, vol. 11(05), pages 1131-1147, October.
  19. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc.
  20. Hjalmarsson, Erik, 2005. "On the Predictability of Global Stock Returns," Working Papers in Economics 161, University of Gothenburg, Department of Economics.
  21. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  22. Erik Hjalmarsson, 2005. "Estimation of average local-to-unity roots in heterogenous panels," International Finance Discussion Papers 852, Board of Governors of the Federal Reserve System (U.S.).
  23. Peter C.B. Phillips & Victor Solo, 1989. "Asymptotics for Linear Processes," Cowles Foundation Discussion Papers 932, Cowles Foundation for Research in Economics, Yale University.
  24. Lewellen, Jonathan, 2003. "Predicting Returns With Financial Ratios," Working papers 4374-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  25. repec:cup:etheor:v:11:y:1995:i:5:p:1131-47 is not listed on IDEAS
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