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On the Properties of Regression Tests of Asset Return Predictability

Author

Listed:
  • Seongman Moon

    () (Universidad Carlos III de Madrid)

  • Carlos Velasco

    () (Universidad Carlos III de Madrid)

Abstract

This paper investigates, both in finite samples and asymptotically, statistical inference on predictive regressions where time series are generated by present value models of asset prices. We show that regression-based tests, including robust tests such as robust conditional test and Q-test, are inconsistent and thus suffer from lack of power in local-to-unity models for the regressor persistence. The main reason is that the near-integrated regressor from the present value model slows down the convergence rates of the estimates, an effect which is masked in predictive regressions analysis with exogenous constant covariance of innovations. We illustrate these properties in a simulation study and analyze the predictability of several stock returns series.

Suggested Citation

  • Seongman Moon & Carlos Velasco, 2011. "On the Properties of Regression Tests of Asset Return Predictability," Working Papers 1111, Research Institute for Market Economy, Sogang University.
  • Handle: RePEc:sgo:wpaper:1111
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    File URL: ftp://163.239.156.99/wpaper/MSM_RIME_2011-11.pdf
    File Function: First version, 2011
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    Cited by:

    1. Seongman Moon & Carlos Velasco, 2011. "The Forward Discount Puzzle: Identi cation of Economic Assumptions," Working Papers 1112, Research Institute for Market Economy, Sogang University.

    More about this item

    Keywords

    present value model; predictive regression; local-to-unity assumption; conditional test; Q-test; t-test.;

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G1 - Financial Economics - - General Financial Markets

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