Predictive Quantile Regressions with Persistent and Heteroskedastic Predictors: A Powerful 2SLS Testing Approach

Matei Demetrescu, Paulo Rodrigues and AM Robert Taylor

Essex Finance Centre Working Papers from University of Essex, Essex Business School

Abstract: We develop new tests for predictability, based on the Lagrange Multiplier [LM] principle, in the context of quantile regression [QR] models which allow for persistent and endogenous predictors driven by conditionally and/or unconditionally heteroskedastic errors. Of the extant predictive QR tests in the literature, only the moving blocks bootstrap implementation, due to Fan and Lee (2019), of theWald-type test of Lee (2016) can allow for conditionally heteroskedastic errors in the context of a QR model with persistent predictors. In common with all other tests in the literature it cannot, however, allow for any form of unconditionally heteroskedastic behaviour in the errors. The LM-based approach we adopt in this paper is obtained from a simple auxiliary linear test regression which facilitates inference based on established instrumental variable methods. We demonstrate that, as a result, the tests we develop, based on either conventional or heteroskedasticity-consistent standard errors in the auxiliary regression, are robust under the null hypothesis of no predictability to conditional heteroskedasticity and to unconditional heteroskedasticity in the errors driving the predictors, with no need for bootstrap implementation. Tests are developed both for predictability at a single quantile, and also jointly over a set of quantiles. Simulation results highlight the superior finite sample size and power properties of our proposed LM tests over the tests of Lee (2016) and Fan and Lee (2019) for both conditionally and unconditionally heteroskedastic errors. An empirical application to the equity premium for the S&P 500 highlights the practical usefulness of our proposed tests, uncovering significant evidence of predictability in the left and right tails of the returns distribution for a number of predictors containing information on market or firm risk.

Keywords: Predictive regression; Conditional quantile; Unknown persistence; Endogeneity; Time-varying volatility (search for similar items in EconPapers)
Date: 2024-01-03
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-rmg
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