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The Stambaugh bias in panel predictive regressions

  • Erik Hjalmarsson

This paper analyzes predictive regressions in a panel data setting. The standard fixed effects estimator suffers from a small sample bias, which is the analogue of the Stambaugh bias in time-series predictive regressions. Monte Carlo evidence shows that the bias and resulting size distortions can be severe. A new bias-corrected estimator is proposed, which is shown to work well in finite samples and to lead to approximately normally distributed t-statistics. 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. The results are illustrated with an application to predictability in international stock indices.

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File URL: http://www.federalreserve.gov/pubs/ifdp/2007/914/ifdp914.pdf
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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 914.

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Date of creation: 2007
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Handle: RePEc:fip:fedgif:914
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  1. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  2. Peter C. B. Phillips & Hyungsik R. Moon, 1999. "Linear Regression Limit Theory for Nonstationary Panel Data," Econometrica, Econometric Society, vol. 67(5), pages 1057-1112, September.
  3. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July.
  4. 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.
  5. Hjalmarsson, Erik, 2010. "Predicting Global Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(01), pages 49-80, February.
  6. Moon, Hyungsik R. & Phillips, Peter C.B., 2000. "Estimation Of Autoregressive Roots Near Unity Using Panel Data," Econometric Theory, Cambridge University Press, vol. 16(06), pages 927-997, December.
  7. Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2001. "The Value Spread," NBER Working Papers 8242, National Bureau of Economic Research, Inc.
  8. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, vol. 74(2), pages 209-235, November.
  9. 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.
  10. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
  11. repec:rus:hseeco:52003 is not listed on IDEAS
  12. repec:cup:etheor:v:11:y:1995:i:5:p:1131-47 is not listed on IDEAS
  13. 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.
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