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On the Properties of Regression Tests of Asset Return Predictability

33 Pages Posted: 24 Sep 2010 Last revised: 15 Mar 2011

Carlos Velasco

Universidad Carlos III de Madrid - Department of Economics

Seongman Moon

Universidad Carlos III de Madrid - Department of Economics

Date Written: December 13, 2010

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.

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

JEL Classification: C12, C22, G1

Suggested Citation

Velasco, Carlos and Moon, Seongman, On the Properties of Regression Tests of Asset Return Predictability (December 13, 2010). Available at SSRN: https://ssrn.com/abstract=1681321 or http://dx.doi.org/10.2139/ssrn.1681321

Carlos Velasco

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain
+34-91 6249646 (Phone)
+34-91 6249875 (Fax)

Seongman Moon (Contact Author)

Universidad Carlos III de Madrid - Department of Economics ( email )

Calle Madrid 126
Getafe, 28903
Spain

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