On the Properties of Regression Tests of Stock Return Predictability Using Dividend-Price Ratios

Seongman Moon and Carlos Velasco

Journal of Financial Econometrics, 2013, vol. 12, issue 1, 151-173

Abstract: This article investigates, both in finite samples and asymptotically, statistical inference on predictive regressions where time series are generated by present value models of stock prices. We show that regression-based tests, including robust tests such as the conditional test and the Q-test, are inconsistent and thus suffer from lack of power in local-to-unity models for the regressor persistence. The main reason is that, despite the near-integrated dividend-price ratio, the convergence rates of the estimates are slowed down because the present value model implies a shrinking innovation variance on the predictor, an effect which is masked in a predictive regression analysis with exogenous constant covariance of innovations. We illustrate these properties in a simulation study. Copyright The Author, 2013. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oup.com, Oxford University Press.

Date: 2013
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