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Small-sample tests for stock return predictability with possibly non-stationary regressors and GARCH-type effects

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  • Gungor, Sermin
  • Luger, Richard

Abstract

We develop a simulation-based procedure to test for stock return predictability with multiple regressors. The process governing the regressors is left completely free and the test procedure remains valid in small samples even in the presence of non-normalities and GARCH-type effects in the stock returns. The usefulness of the new procedure is demonstrated in a simulation study and by examining the ability of a group of financial variables to predict excess stock returns. We find some evidence of predictability during the period 1948–2014, driven entirely by the term spread. This empirical evidence, however, is much weaker over subsamples.

Suggested Citation

  • Gungor, Sermin & Luger, Richard, 2020. "Small-sample tests for stock return predictability with possibly non-stationary regressors and GARCH-type effects," Journal of Econometrics, Elsevier, vol. 218(2), pages 750-770.
    • Handle: RePEc:eee:econom:v:218:y:2020:i:2:p:750-770
    DOI: 10.1016/j.jeconom.2020.04.037
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    1. Christis Katsouris, 2023. "Predictability Tests Robust against Parameter Instability," Papers 2307.15151, arXiv.org.
    2. Yijie Fei & Yiu Lim Lui & Jun Yu, 2024. "Testing Predictability in the Presence of Persistent Errors," Working Papers 202401, University of Macau, Faculty of Business Administration.
    3. Pitarakis, Jean-Yves, 2019. "Predictive Regressions," UC3M Working papers. Economics 28554, Universidad Carlos III de Madrid. Departamento de Economía.
    4. Giraldo, Carlos & Giraldo, Iader & Gomez-Gonzalez, Jose E. & Uribe, Jorge M., 2024. "Term Spread Spillovers to Latin America and Emergence of the ‘Twin Ds’," Documentos de trabajo 21169, FLAR.
    5. Fu, Hsuan & Luger, Richard, 2022. "Multiple testing of the forward rate unbiasedness hypothesis across currencies," Journal of Empirical Finance, Elsevier, vol. 68(C), pages 232-245.

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    More about this item

    Keywords

    Stock returns; Predictive regression; Multiple predictors; Unit roots; Conditional heteroskedasticity; Robust inference;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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