Testing for monotonicity in expected asset returns

Joseph P. Romano and Michael Wolf

No 17, ECON - Working Papers from Department of Economics - University of Zurich

Abstract: Many postulated relations in finance imply that expected asset returns strictly increase in an underlying characteristic. To examine the validity of such a claim, one needs to take the entire range of the characteristic into account, as is done in the recent proposal of Patton and Timmermann (2010). But their test is only a test for the direction of monotonicity, since it requires the relation to be monotonic from the outset: either weakly decreasing under the null or strictly increasing under the alternative. When the relation is non-monotonic or weakly increasing, the test can break down and falsely ‘establish’ a strictly increasing relation with high probability. We offer some alternative tests that do not share this problem. The behavior of the various tests is illustrated via Monte Carlo studies. We also present empirical applications to real data.

Keywords: Bootstrap; CAPM; monotonicity tests; non-monotonic relations (search for similar items in EconPapers)
JEL-codes: C12 C58 G12 G14 (search for similar items in EconPapers)
Date: 2011-05, Revised 2013-01
New Economics Papers: this item is included in nep-ecm
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:zur:econwp:017

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