Testing the economic value of asset return predictability
Economic value calculations are increasingly used to compare the predictive performance of competing models of asset returns. However, they lack a rigorous way to validate their evidence. This paper proposes a new methodology to test whether utility gains accruing to investors using competing predictive models are equal to zero. Monte Carlo evidence indicates that our testing procedure, that can account for estimation error in the asymptotic variance of the test statistic, provides accurately sized and powerful tests in empirically relevant sample sizes. We apply the test statistics proposed in the paper to revisit the predictability of the US equity premium by means of various predictors.
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- Patton, Andrew J. & Timmermann, Allan, 2007.
"Properties of optimal forecasts under asymmetric loss and nonlinearity,"
Journal of Econometrics,
Elsevier, vol. 140(2), pages 884-918, October.
- Allan Timmermann & Andrew Patton, 2004. "Properties of Optimal Forecasts under Asymmetric Loss and Nonlinearity," Working Papers wp04-05, Warwick Business School, Finance Group.
- Valentina Corradi & Norman R. Swanson, 2007.
"Nonparametric Bootstrap Procedures For Predictive Inference Based On Recursive Estimation Schemes,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 48(1), pages 67-109, 02.
- Norman Swanson & Valentina Corradi, 2006. "Nonparametric Bootstrap Procedures for Predictive Inference Based on Recursive Estimation Schemes," Departmental Working Papers 200618, Rutgers University, Department of Economics.
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