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HACking at Non-linearity: Evidence from Stocks and Bonds

Author

Listed:
  • Robert J Bianchi

    () (School of Economics and Finance, Queensland University of Technology)

  • Adam E Clements

    () (School of Economics and Finance, Queensland University of Technology)

  • Michael E Drew

Abstract

The implicit assumption of linearity is an important element in empirical finance. This study presents a hypothesis testing approach which examines the linear behaviour of the conditional mean between stock and bond returns. Conventional tests detect spurious non-linearity in the conditional mean caused by heteroskedasticity and/or autocorrelation. This study re-states these tests in a heteroskedasticity and autocorrelation consistent (HAC) framework and we find that stock and bond returns are indeed linear-in-the-mean in both univariate and bivariate settings. This study contends that previous research may have detected spurious non-linearity due to size distortions caused by heteroskedasticity and autocorrelation, rather than the presence of genuine non-linearity.

Suggested Citation

  • Robert J Bianchi & Adam E Clements & Michael E Drew, 2009. "HACking at Non-linearity: Evidence from Stocks and Bonds," School of Economics and Finance Discussion Papers and Working Papers Series 244, School of Economics and Finance, Queensland University of Technology.
  • Handle: RePEc:qut:dpaper:244
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    File URL: http://external-apps.qut.edu.au/business/documents/discussionPapers/2009/244Bianchi.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    linearity; nonlinear; heteroskedasticity-robust tests; autocorrelation-robust tests;

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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