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The Long and the Short of It: Long Memory Regressors and Predictive Regressions

Aaron Smallwood; Alex Maynard; Mark Wohar
Authors registered in the RePEc Author Service: Alex S. Maynard, Aaron Smallwood and Mark Wohar ()

No 384, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: Persistent regressors pose a common problem in predictive regressions. Tests of the forward rate unbiased hypothesis (FRUH) constitute a prime example. Standard regression tests that strongly reject FRUH have been questioned on the grounds of potential long-memory in the forward premium. Researchers have argued that this could create a regression imbalance thereby invalidating standard statistical inference. To address this concern we employ a two-step procedure that rebalances the predictive equation, while still permitting us to impose the null of FRUH. We conduct a comprehensive simulation study to validate our procedure. The simulations demonstrate the good small sample performance of our two-stage procedure, and its robustness to possible errors in the first stage estimation of the memory parameter. By contrast, the simulations for standard regression tests show the potential for significant size distortion, validating the concerns of previous researchers. Our empirical application to excess returns, suggests less evidence against FRUH than found using the standard, but possibly questionable, t-tests.

Keywords: Long Memory; Predictive Regressions; Forward Rate Unbiasedness Hypothesis (search for similar items in EconPapers)
JEL-codes: C12 C22 F31 (search for similar items in EconPapers)
Date: 2005-11-11
New Economics Papers: this item is included in nep-ecm and nep-ets
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Persistent link: https://EconPapers.repec.org/RePEc:sce:scecf5:384

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