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Working Paper
A residual-based cointegration test for near unit root variables
Methods of inference based on a unit root assumption in the data are typically not robust to even small deviations from this assumption. In this paper, we propose robust procedures for a residual-based test of cointegration when the data are generated by a near unit root process. A Bonferroni method is used to address the uncertainty regarding the exact degree of persistence in the process. We thus provide a method for valid inference in multivariate near unit root processes where standard cointegration tests may be subject to substantial size distortions and standard OLS inference may lead ...
Working Paper
Predictive regressions with panel data
This paper analyzes panel data inference in predictive regressions with endogenous and nearly persistent regressors. The standard fixed effects estimator is shown to suffer from a second order bias; analytical results, as well as Monte Carlo evidence, show that the bias and resulting size distortions can be severe. New estimators, based on recursive demeaning as well as direct bias correction, are proposed and methods for dealing with cross sectional dependence in the form of common factors are also developed. Overall, the results show that the econometric issues associated with predictive ...
Working Paper
Testing the expectations hypothesis when interest rates are near integrated
Nominal interest rates are unlikely to be generated by unit-root processes. Using data on short and long interest rates from eight developed and six emerging economies, we test the expectations hypothesis using cointegration methods under the assumption that interest rates are near integrated. If the null hypothesis of no cointegration is rejected, we then test whether the estimated cointegrating vector is consistent with that suggested by the expectations hypothesis. The results show support for cointegration in ten of the fourteen countries we consider, and the cointegrating vector is ...
Working Paper
Should we expect significant out-of-sample results when predicting stock returns?
Using Monte Carlo simulations, I show that typical out-of-sample forecast exercises for stock returns are unlikely to produce any evidence of predictability, even when there is in fact predictability and the correct model is estimated.
Working Paper
Rise of the machines: algorithmic trading in the foreign exchange market
We study the impact that algorithmic trading, computers directly interfacing at high frequency with trading platforms, has had on price discovery and volatility in the foreign exchange market. Our dataset represents a majority of global interdealer trading in three major currency pairs in 2006 and 2007. Importantly, it contains precise observations of the size and the direction of the computer-generated and human-generated trades each minute. The empirical analysis provides several important insights. First, we find evidence that algorithmic trades tend to be correlated, suggesting that the ...
Working Paper
What drives volatility persistence in the foreign exchange market?
We analyze the factors driving the widely-noted persistence in asset return volatility using a unique dataset on global euro-dollar exchange rate trading. We propose a new simple empirical specification of volatility, based on the Kyle-model, which links volatility to the information flow, measured as the order flow in the market, and the price sensitivity to that information. Through the use of high-frequency data, we are able to estimate the time-varying market sensitivity to information, and movements in volatility can therefore be directly related to movements in two observable variables, ...
Working Paper
Fully modified estimation with nearly integrated regressors
I show that the test procedure derived by Campbell and Yogo (2005, Journal of Financial Economics, forthcoming) for regressions with nearly integrated variables can be interpreted as the natural t-test resulting from a fully modified estimation with near-unit-root regressors. This clearly establishes the methods of Campbell and Yogo as an extension of previous unit-root results.
Working Paper
Frequency of observation and the estimation of integrated volatility in deep and liquid financial markets
Using two newly available ultrahigh-frequency datasets, we investigate empirically how frequently one can sample certain foreign exchange and U.S. Treasury security returns without contaminating estimates of their integrated volatility with market microstructure noise. Using volatility signature plots and a recently-proposed formal decision rule to select the sampling frequency, we find that one can sample FX returns as frequently as once every 15 to 20 seconds without contaminating volatility estimates; bond returns may be sampled as frequently as once every 2 to 3 minutes on days without ...
Working Paper
Diversification across characteristics
I study long-short portfolio strategies formed on seven different stock characteristics representing various measures of past returns, value, and size. Each individual characteristic results in a profitable portfolio strategy, but these single-characteristic strategies are all dominated by a diversified strategy that places equal weight on each of the single-characteristic strategies. The benefits of diversifying across characteristic-based long-short strategies are substantial and can be attributed to the mostly low, and sometimes substantially negative, correlation between the returns on ...
Working Paper
Interpreting long-horizon estimates in predictive regressions
This paper analyzes the asymptotic properties of long-horizon estimators under both the null hypothesis and an alternative of predictability. Asymptotically, under the null of no predictability, the long-run estimator is an increasing deterministic function of the short-run estimate and the forecasting horizon. Under the alternative of predictability, the conditional distribution of the long-run estimator, given the short-run estimate, is no longer degenerate and the expected pattern of coefficient estimates across horizons differs from that under the null. Importantly, however, under the ...