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The Compass Rose Pattern of the Stock Market: How Does it Affect Parameter Estimates, Forecasts, and Statistical Tests?

Author

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  • Amilon , Henrik

    () (Department of Economics, Lund University)

  • Byström , Hans

    () (Department of Economics, Lund University)

Abstract

A "compass rose" pattern sometimes appears when stock returns are plotted against themselves with a one-day lag, since stock prices move in discrete steps. In this paper, we perform a Monte Carlo study on simulated stock price series rounded in different ways to mirror the behavior of stocks on the Stockholm Stock Exchange. We find AR-GARCH parameter estimates to be affected by the discreteness imposed by rounding. Based on the compass rose and the discreteness, we investigate, theoretically and empirically, different possibilities of improving predictions of stock returns. The distributions of the BDS test as well as Savit and Green's dependability index are also influenced by the compass rose pattern. However, throughout the paper, we must impose unrealistically heavy rounding of the stock prices to find significant effects on our estimates, forecasts, and statistical tests.

Suggested Citation

  • Amilon , Henrik & Byström , Hans, 2000. "The Compass Rose Pattern of the Stock Market: How Does it Affect Parameter Estimates, Forecasts, and Statistical Tests?," Working Papers 2000:18, Lund University, Department of Economics.
  • Handle: RePEc:hhs:lunewp:2000_018
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    References listed on IDEAS

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    1. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    2. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
    3. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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    More about this item

    Keywords

    discrete prices; GARCH; forecasts; correlation integral statistics;

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G19 - Financial Economics - - General Financial Markets - - - Other

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