Testing for Episodic Predictability in Stock Returns
Matei Demetrescu (),
Paulo Rodrigues () and
AM Robert Taylor
Essex Finance Centre Working Papers from University of Essex, Essex Business School
Standard tests based on predictive regressions estimated over the full available sample data have tended to find little evidence of predictability in stock returns. Recent approaches based on the analysis of subsamples of the data have been considered, suggesting that predictability where it occurs might exist only within so-called 'pockets of predictability' rather than across the entire sample. However, these methods are prone to the criticism that the sub-sample dates are endogenously determined such that the use of standard critical values appropriate for full sample tests will result in incorrectly sized tests leading to spurious findings of stock returns predictability. To avoid the problem of endogenously-determined sample splits, we propose new tests derived from sequences of predictability statistics systematically calculated over sub-samples of the data. Specifically, we will base tests on the maximum of such statistics from sequences of forward and backward recursive, rolling, and double-recursive predictive sub-sample regressions. We develop our approach using the over-identified instrumental variable-based predictability test statistics of Breitung and Demetrescu (2015). This approach is based on partial-sum asymptotics and so, unlike many other popular approaches including, for example, those based on Bonferroni corrections, can be readily adapted to implementation over sequences of subsamples. We show that the limiting distributions of our proposed tests are robust to both the degree of persistence and endogeneity of the regressors in the predictive regression, but not to any heteroskedasticity present even if the sub-sample statistics are based on heteroskedasticity-robust standard errors. We therefore develop fixed regressor wild bootstrap implementations of the tests which we demonstrate to be first-order asymptotically valid. Finite sample behaviour against a variety of temporarily predictable processes is considered. An empirical application to US stock returns illustrates the usefulness of the new predictability testing methods we propose.
Keywords: predictive regression; rolling and recursive IV estimation; persistence; endogeneity; conditional and unconditional heteroskedasticity (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-fmk
References: Add references at CitEc
Citations: View citations in EconPapers (1) Track citations by RSS feed
Downloads: (external link)
http://repository.essex.ac.uk/24137/ original version (application/pdf)
Journal Article: Testing for episodic predictability in stock returns (2022)
Working Paper: Testing for Episodic Predictability in Stock Returns (2019)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:esy:uefcwp:24137
Access Statistics for this paper
More papers in Essex Finance Centre Working Papers from University of Essex, Essex Business School Contact information at EDIRC.
Bibliographic data for series maintained by Nikolaos Vlastakis ( this e-mail address is bad, please contact ).