Nonparametric Retrospection and Monitoring of Predictability of Financial Returns
35 Pages Posted: 21 Jul 2006 Last revised: 17 Sep 2008
Date Written: August 24, 2007
We develop and evaluate sequential testing tools for a class of nonparametric tests for predictability of financial returns that includes, in particular, the directional accuracy and excess profitability tests. Our sequential methods consider in a unified framework both retrospection of a historical sample and monitoring newly arriving data. To this end, we focus on linear monitoring boundaries that are continuations of horizontal lines corresponding to retrospective critical values, elaborating on both two-sided and one-sided testing. We run a simulation study and illustrate the methodology by testing for directional and mean predictability of returns in young stock markets in Eastern Europe.
Keywords: Predictability testing, sequential tests, retrospection, monitoring, stock indexes
JEL Classification: C12, C22, C52, C53
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