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Band Covariance Matrix Estimation Using Restricted Residuals: A Monte Carlo Analysis

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  • Ligeralde, Antonio V
  • Brown, Bryan W

Abstract

Using Monte Carlo simulations, the authors examine the performance of Wald-type test statistics based on alternative versions of a heteroskedasticity consistent band covariance matrix estimator that is algorithmically constrained to be positive definite in finite samples. They find that the test statistic based on the originally proposed estimator tends to result in excessive type I errors. This problem can be alleviated to some extent by employing a quasi-maximum likelihood procedure. However, by simply using restricted, as opposed to the usual OLS residuals when constructing the band covariance matrix estimator, excessive type I errors can be substantially reduced, if not eliminated. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Ligeralde, Antonio V & Brown, Bryan W, 1995. "Band Covariance Matrix Estimation Using Restricted Residuals: A Monte Carlo Analysis," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(3), pages 751-767, August.
    • Handle: RePEc:ier:iecrev:v:36:y:1995:i:3:p:751-67
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    Cited by:

    1. Ligeralde, Antonio V., 1997. "Covariance matrix estimators and tests of market efficiency," Journal of International Money and Finance, Elsevier, vol. 16(2), pages 323-343, April.

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