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Predictive regressions with panel data

  • Hjalmarsson, Erik


    (Department of Economics)

This paper analyzes econometric inference in predictive regressions in a panel data setting. In a traditional time-series framework, estimation and testing are often made difficult by the endogeneity and near persistence of many forecasting variables; tests of whether the dividend-price ratio predicts stock returns is a prototypical example. I show that, by pooling the data, these econometric issues can be dealt with more easily. When no individual intercepts are included in the pooled regression, the pooled estimator has an asymptotically normal distribution and standard tests can be performed. However, when fixed effects are included in the specification, a second order bias in the fixed effects estimator arises from the endogeneity and persistence of the regressors. A new estimator based on recursive demeaning is proposed and its asymptotic normality is derived; the procedure requires no knowledge of the degree of persistence in the regressors and thus sidesteps the main inferential problems in the time-series case. Since forecasting regressions are typically applied to financial or macroeconomic data, the traditional panel data assumption of cross-sectional independence is likely to be violated. New methods for dealing with common factors in the data are therefore also developed. The analytical results derived in the paper are supported by Monte Carlo evidence.

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Paper provided by University of Gothenburg, Department of Economics in its series Working Papers in Economics with number 160.

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Length: 42 pages
Date of creation: 02 Feb 2005
Date of revision:
Handle: RePEc:hhs:gunwpe:0160
Contact details of provider: Postal:
Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GĂ–TEBORG, Sweden

Phone: 031-773 10 00
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  1. 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.
  2. John Y. Campbell & Motohiro Yogo, 2002. "Efficient Tests of Stock Return Predictability," Harvard Institute of Economic Research Working Papers 1972, Harvard - Institute of Economic Research.
  3. 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.
  4. 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.
  5. Lewellen, Jonathan, 2003. "Predicting Returns With Financial Ratios," Working papers 4374-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  6. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  7. Donald W. K. Andrews, 2005. "Cross-Section Regression with Common Shocks," Econometrica, Econometric Society, vol. 73(5), pages 1551-1585, 09.
  8. 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.
  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. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research.
  11. repec:cup:etheor:v:11:y:1995:i:5:p:1131-47 is not listed on IDEAS
  12. Hjalmarsson, Erik, 2005. "On the Predictability of Global Stock Returns," Working Papers in Economics 161, University of Gothenburg, Department of Economics.
  13. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, vol. 74(2), pages 209-235, November.
  14. Donggyu Sul & Peter C. B. Phillips & Chi-Young Choi, 2005. "Prewhitening Bias in HAC Estimation," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(4), pages 517-546, 08.
  15. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc.
  16. Peter C. B. Phillips & Bruce E. Hansen, 1990. "Statistical Inference in Instrumental Variables Regression with I(1) Processes," Review of Economic Studies, Oxford University Press, vol. 57(1), pages 99-125.
  17. 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.
  18. 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.
  19. Pagan,Adrian & Ullah,Aman, 1999. "Nonparametric Econometrics," Cambridge Books, Cambridge University Press, number 9780521586115, September.
  20. 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.
  21. M. Hashem Pesaran, 2006. "Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure," Econometrica, Econometric Society, vol. 74(4), pages 967-1012, 07.
  22. 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.
  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. 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.).
  25. 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.
  26. 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.
  27. repec:cdl:ucsbec:1-99 is not listed on IDEAS
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