Unbalanced Regressions and the Predictive Equation

Daniela Osterrieder (), Daniel Ventosa-Santaulària and J. Eduardo Vera-Valdés
Additional contact information
Daniela Osterrieder: Rutgers Business School and CREATES, Postal: Department of Finance and Economics, 1 Washington Park, Newark NJ 07102

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: Predictive return regressions with persistent regressors are typically plagued by (asymptotically) biased/inconsistent estimates of the slope, non-standard or potentially even spurious statistical inference, and regression unbalancedness. We alleviate the problem of unbalancedness in the theoretical predictive equation by suggesting a data generating process, where returns are generated as linear functions of a lagged latent I(0) risk process. The observed predictor is a function of this latent I(0) process, but it is corrupted by a fractionally integrated noise. Such a process may arise due to aggregation or unexpected level shifts. In this setup, the practitioner estimates a misspecified, unbalanced, and endogenous predictive regression. We show that the OLS estimate of this regression is inconsistent, but standard inference is possible. To obtain a consistent slope estimate, we then suggest an instrumental variable approach and discuss issues of validity and relevance. Applying the procedure to the prediction of daily returns on the S&P 500, our empirical analysis confirms return predictability and a positive risk-return trade-off.

Keywords: Title:; Time-varying; disaster; risk; models:; An; empirical; assessment; of; the; Rietz-Barro; hypothesis (search for similar items in EconPapers)
JEL-codes: C22 C26 C58 G17 (search for similar items in EconPapers)
Pages: 56
Date: 2015-01-29
New Economics Papers: this item is included in nep-ecm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://repec.econ.au.dk/repec/creates/rp/15/rp15_09.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2015-09

Access Statistics for this paper

More papers in CREATES Research Papers from Department of Economics and Business Economics, Aarhus University
Bibliographic data for series maintained by ().