Size and power of tests based on Permanent-Transitory Component Models

Fabrizio Casalin

International Review of Financial Analysis, 2016, vol. 47, issue C, 142-153

Abstract: The literature has recently proposed a new type of tests for the Efficient Market Hypothesis based on Permanent-Transitory Component Models. We compare the power of these statistics with conventional tests based on linear regressions. Simulation results suggest that the former dominate the latter for a wide range of data generating processes. We propose an application to spot and forward interest rates. Empirical results show that the two types of tests can yield conflicting results which can be explained by the size distortions and reduced power which affect the statistics based on linear regressions.

Keywords: Efficient Markets Hypothesis; Permanent-Transitory Component Models; MC simulations (search for similar items in EconPapers)
JEL-codes: C32 F47 G17 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:47:y:2016:i:c:p:142-153

DOI: 10.1016/j.irfa.2016.07.003

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