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An out-of-sample test for nonlinearity in financial time series: An empirical application

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Abstract

This paper employs a local information, nearest neighbour forecasting methodology to test for evidence of nonlinearity in financial time series. Evidence from well-known data generating process are provided and compared with returns from the Athens stock exchange given the in-sample evidence of nonlinear dynamics that has appeared in the literature. Nearest neighbour forecasts fail to produce more accurate forecasts from a simple AR model. This does not substantiate the presence of in-sample nonlinearity in the series.

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  • Theodore Panagiotidis, 2010. "An out-of-sample test for nonlinearity in financial time series: An empirical application," Discussion Paper Series 2010_08, Department of Economics, University of Macedonia, revised Jun 2010.
    • Handle: RePEc:mcd:mcddps:2010_08
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    1. LeBaron, Blake, 1992. "Forecast Improvements Using a Volatility Index," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages 137-149, Suppl. De.
    2. Theodore Panagiotidis, 2010. "Market efficiency and the Euro: the case of the Athens stock exchange," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 37(3), pages 237-251, July.
    3. Granger Clive W.J., 2008. "Non-Linear Models: Where Do We Go Next - Time Varying Parameter Models?," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 12(3), pages 1-11, September.
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    5. Jaditz Ted & Riddick Leigh A., 2000. "Time-Series Near-Neighbor Regression," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 4(1), pages 1-11, April.
    6. A. I. McLeod & W. K. Li, 1983. "Diagnostic Checking Arma Time Series Models Using Squared‐Residual Autocorrelations," Journal of Time Series Analysis, Wiley Blackwell, vol. 4(4), pages 269-273, July.
    7. Jaditz, Ted & Riddick, Leigh A. & Sayers, Chera L., 1998. "MULTIVARIATE NONLINEAR FORECASTING Using Financial Information to Forecast the Real Sector," Macroeconomic Dynamics, Cambridge University Press, vol. 2(3), pages 369-382, September.
    8. Jaditz, Ted & Sayers, Chera L, 1998. "Out-of-Sample Forecast Performance as a Test for Nonlinearity in Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(1), pages 110-117, January.
    9. David Chappell & Theodore Panagiotidis, 2005. "Using the correlation dimension to detect non-linear dynamics: Evidence from the Athens Stock Exchange," Econometrics 0504005, University Library of Munich, Germany.
    10. Fernandez-Rodriguez, Fernando & Sosvilla-Rivero, Simon, 1998. "Testing nonlinear forecastability in time series: Theory and evidence from the EMS," Economics Letters, Elsevier, vol. 59(1), pages 49-63, April.
    11. Agnon, Yehuda & Golan, Amos & Shearer, Matthew, 1999. "Nonparametric, nonlinear, short-term forecasting: theory and evidence for nonlinearities in the commodity markets," Economics Letters, Elsevier, vol. 65(3), pages 293-299, December.
    12. Mizrach, B, 1992. "Multivariate Nearest-Neighbor Forecasts of EMS Exchange Rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages 151-163, Suppl. De.
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    Cited by:

    1. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2013. "Some thoughts on accurate characterization of stock market indexes trends in conditions of nonlinear capital flows during electronic trading at stock exchanges in global capital markets," MPRA Paper 49921, University Library of Munich, Germany.

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    More about this item

    Keywords

    nearest neighbour; nonlinearity;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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