Tests of Equal Accuracy for Nested Models with Estimated Factors

51 Pages Posted: 6 Oct 2015 Last revised: 6 Mar 2019

See all articles by Sílvia Gonçalves

Sílvia Gonçalves

University of Montreal - Department of Economics

Michael W. McCracken

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Benoit Perron

University of Montreal - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); University of Montreal - Center for Interuniversity Research in Econometrics

Date Written: 2015-09-14

Abstract

In this paper we develop asymptotics for tests of equal predictive ability between nested models when factor-augmented regression models are used to forecast. We provide conditions under which the estimation of the factors does not affect the asymptotic distributions developed in Clark and McCracken (2001) and McCracken (2007). This enables researchers to use the existing tabulated critical values when conducting inference. As an intermediate result, we derive the asymptotic properties of the principal components estimator over recursive windows. We provide simulation evidence on the finite sample effects of factor estimation and apply the tests to the case of forecasting excess returns to the S&P 500 Composite Index.

Keywords: factor model, out-of-sample forecasts, recursive estimation

JEL Classification: C12, C32, C38, C52

Suggested Citation

Goncalves, Silvia and McCracken, Michael W. and Perron, Benoit, Tests of Equal Accuracy for Nested Models with Estimated Factors (2015-09-14). FRB St. Louis Working Paper No. 2015-25. Available at SSRN: https://ssrn.com/abstract=2669857

Silvia Goncalves (Contact Author)

University of Montreal - Department of Economics ( email )

C.P. 6128, succursale Centre-Ville
Montreal, Quebec H3C 3J7
Canada

Michael W. McCracken

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Benoit Perron

University of Montreal - Department of Economics ( email )

C.P. 6128, succursale Centre-Ville
Montreal, Quebec H3C 3J7
Canada
514-343-2126 (Phone)
514-343-5831 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

1130 Sherbrooke west, 14th floor
Montreal H3A 2M8, Quebec
Canada

University of Montreal - Center for Interuniversity Research in Econometrics ( email )

C.P. 6128, Succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

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