A Note on Nonsense Predictive Regressions Arising from Structural Breaks

Abstract:     
In this short note we respond to the argument advanced by Baker, Taliaferro, and Wurgler (2006) that our criticism of the market timing literature is simply a reinterpretation of Stambaugh's (1999) small sample bias. We show analytically how structural breaks in an economic time-series may result in spurious, or nonsense, predictive regressions, whether or not there is any small-sample bias at play. We also provide a simple example showing that the magnitude of this bias could explain the predictive power of certain variables.

Keywords: Market Timing, Spurious Regressions

JEL Classifications: G14, G32

Working Paper Series