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Hypothesis Testing in Predictive Regressions

Author

Listed:
  • Yakov Amihud

    (New York University)

  • Clifford Hurvich

    (New York University)

  • Yi Wang

    (New York University)

Abstract

We propose a new hypothesis testing method for multi-predictor regressions with finite samples, where the dependent variable is regressed on lagged variables that are autoregressive. It is based on the augmented regressiom method (ARM; Amihud and Hurvich (2004)), which produces reduced-bias coefficients and is easy to implement. The method's usefulness is demonstrated by simulations and by an empirical example, where stock returns are predicted by dividend yield and by bond yield spread. For single-predictor regressions, we show that the ARM outperforms bootstrapping and that the ARM performs better than Lewellen's (2003) method in many situations.

Suggested Citation

  • Yakov Amihud & Clifford Hurvich & Yi Wang, 2004. "Hypothesis Testing in Predictive Regressions," Finance 0412022, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0412022
    Note: Type of Document - pdf; pages: 47
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    References listed on IDEAS

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    1. Lewellen, Jonathan, 2003. "Predicting Returns With Financial Ratios," Working papers 4374-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    2. Amihud, Yakov, 2002. "Illiquidity and stock returns: cross-section and time-series effects," Journal of Financial Markets, Elsevier, vol. 5(1), pages 31-56, January.
    3. Nelson, Charles R & Kim, Myung J, 1993. "Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-661, June.
    4. Amihud, Yakov & Hurvich, Clifford M., 2004. "Predictive Regressions: A Reduced-Bias Estimation Method," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(4), pages 813-841, December.
    5. Baker, Malcolm & Stein, Jeremy C., 2004. "Market liquidity as a sentiment indicator," Journal of Financial Markets, Elsevier, vol. 7(3), pages 271-299, June.
    6. Kothari, S. P. & Shanken, Jay, 1997. "Book-to-market, dividend yield, and expected market returns: A time-series analysis," Journal of Financial Economics, Elsevier, vol. 44(2), pages 169-203, May.
    7. Polk, Christopher & Thompson, Samuel & Vuolteenaho, Tuomo, 2006. "Cross-sectional forecasts of the equity premium," Journal of Financial Economics, Elsevier, vol. 81(1), pages 101-141, July.
    8. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
    9. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July.
    10. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
    11. Maynard, Alex & Shimotsu, Katsumi, 2009. "Covariance-Based Orthogonality Tests For Regressors With Unknown Persistence," Econometric Theory, Cambridge University Press, vol. 25(1), pages 63-116, February.
    12. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
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    Cited by:

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    4. Maynard, Alex & Shimotsu, Katsumi, 2009. "Covariance-Based Orthogonality Tests For Regressors With Unknown Persistence," Econometric Theory, Cambridge University Press, vol. 25(1), pages 63-116, February.

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    • G - Financial Economics

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