On the Properties of Regression Tests of Asset Return Predictability

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 optimal robust tests such as Jasson and Moreira's conditional test and Campbell and Yogo's 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.

Number of Pages in PDF File: 33

Keywords: t-test, conditional test, Q-test, predictive regression, regressor persistence, contemporaneous correlation

JEL Classification: C12, C22, G1

working papers series