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Unified Tests for a Dynamic Predictive Regression

Bingduo Yang, Xiaohui Liu, Liang Peng and Zongwu Cai
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Bingduo Yang: School of Finance, Jiangxi University of Finance and Economics, Nanchang, China
Xiaohui Liu: School of Finance, Jiangxi University of Finance and Economics, Nanchang, China
Liang Peng: Department of Risk Management and Insurance, Georgia State University
Zongwu Cai: Department of Economics, University of Kansas

No 201808, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: Testing for predictability of asset returns has been a long history in economics and finance. Recently, based on a simple predictive regression, Kostakis, Magdalinos and Stamatogiannis (2015, Review of Financial Studies) derived a Wald type test based on the context of the extended instrumental variable (IVX) methodology for testing predictability of stock returns and Demetrescu (2014) showed that the local power of the standard IVX-based test could be improved in some cases when a lagged predicted variable is added to the predictive regression on purpose, which poses a general important question on whether a lagged predicted variable should be included in the model or not. This paper proposes novel robust procedures for testing both the existence of a lagged predicted variable and the predictability of asset returns in a predictive regression regardless of regressors being stationary or nearly integrated or unit root and the AR model for regressors with or without intercept. A simulation study confirms the good finite sample performance of the proposed tests before applying the proposed tests to some real datasets in finance to illustrate their practical usefulness.

Keywords: Autoregressive Errors; Empirical Likelihood; Predictive Regression; Weighted Score. (search for similar items in EconPapers)
JEL-codes: C12 C22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm and nep-ets
Date: 2018-09, Revised 2018-09
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