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Size and power of tests based on Permanent-Transitory Component Models

Lookup NU author(s): Dr Fabrizio Casalin

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This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License (CC BY-NC-ND).

Abstract

The literature has recently proposed a new type of tests for the Efficient Market Hypothesis based onPermanent-Transitory Component Models. We compare the power of these statistics with conventionaltests based on linear regressions. Simulation results suggest that the former dominate the latter for awide range of data generating processes. We propose an application to spot and forward interest rates.Empirical results show that the two types of tests can yield conflicting results which can be explained bythe size distortions and reduced power which affect the statistics based on linear regressions.

Publication metadata

Author(s): Casalin F

Publication type: Article

Publication status: Published

Journal: International Review of Financial Analysis

Year: 2016

Volume: 47

Pages: 142–153

Print publication date: 01/10/2016

Online publication date: 03/08/2016

Acceptance date: 27/07/2016

Date deposited: 02/06/2016

ISSN (print): 1057-5219

ISSN (electronic): 1873-8079

Publisher: Elsevier

URL: http://dx.doi.org/10.1016/j.irfa.2016.07.003

DOI: 10.1016/j.irfa.2016.07.003

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