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Optimal Instrumental Variables Generators Based on Improved Hausman Regression, with an Application to Hedge Funds Returns

Author

Listed:
  • Francois-Éric Racicot

    () (Département des sciences administratives, Université du Québec (Outaouais), LRSP et Chaire d'information financière et organisationnelle)

  • Raymond Théoret

    () (Département de stratégie des affaires, Université du Québec (Montréal), et Chaire d'information financière et organisationnelle)

Abstract

This paper proposes new Hausman-based estimators lying on cumulants optimal instruments. Using these new generated strong instruments in a GMM setting, we obtain new GMM estimators which we call GMM-C and its homologue, the GMM-hm. This procedure improves the method of moments for identifying the parameters of a model. Also, our study gives way to a new indicator signalling the presence of specification errors in financial models. We apply our battery of tests and estimators to a sample of 22 HFR hedge fund indices observed monthly over the period 1990-2005. Our tests reveal that specification errors corrupt parameters estimation of financial models of returns. Therefore, it is not surprising that the ranking of hedge funds is very sensitive to the choice of estimators. Our new indicator of specification errors reveals itself very powerful to detect those errors.

Suggested Citation

  • Francois-Éric Racicot & Raymond Théoret, 2008. "Optimal Instrumental Variables Generators Based on Improved Hausman Regression, with an Application to Hedge Funds Returns," RePAd Working Paper Series UQO-DSA-wp012008, Département des sciences administratives, UQO.
  • Handle: RePEc:pqs:wpaper:012008
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    File URL: http://www.repad.org/ca/qc/uq/uqo/dsa/fer200805.pdf
    File Function: First version, 2008
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    Cited by:

    1. Francois-Éric Racicot, 2011. "Low-frequency components and the Weekend effect revisited: Evidence from Spectral Analysis," RePAd Working Paper Series UQO-DSA-wp052011, Département des sciences administratives, UQO.

    More about this item

    Keywords

    Asset Pricing Models; specification errors; Hausman test; GMM; optimal instruments.;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C19 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Other
    • C49 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Other
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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