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Jel Classification:C12 

Working Paper
Diverging Tests of Equal Predictive Ability

We investigate claims made in Giacomini and White (2006) and Diebold (2015) regarding the asymptotic normality of a test of equal predictive ability. A counterexample is provided in which, instead, the test statistic diverges with probability one under the null.
Working Papers , Paper 2019-018

Report
Characteristic-Sorted Portfolios: Estimation and Inference

Portfolio sorting is ubiquitous in the empirical finance literature, where it has been widely used to identify pricing anomalies. Despite its popularity, little attention has been paid to the statistical properties of the procedure. We develop a general framework for portfolio sorting by casting it as a nonparametric estimator. We present valid asymptotic inference methods, and a valid mean square error expansion of the estimator leading to an optimal choice for the number of portfolios. In practical settings, the optimal choice may be much larger than standard choices of five or ten. To ...
Staff Reports , Paper 788

Journal Article
Factor-based prediction of industry-wide bank stress

This article investigates the use of factor-based methods for predicting industry-wide bank stress. Specifically, using the variables detailed in the Federal Reserve Board of Governors? bank stress scenarios, the authors construct a small collection of distinct factors. We then investigate the predictive content of these factors for net charge-offs and net interest margins at the bank industry level. The authors find that the factors do have significant predictive content, both in and out of sample, for net interest margins but significantly less predictive content for net charge-offs. ...
Review , Volume 96 , Issue 2 , Pages 173-194

Working Paper
Monetary Policy with Judgment

We consider two approaches to incorporate judgment into DSGE models. First, Bayesian estimation indirectly imposes judgment via priors on model parameters, which are then mapped into a judgmental interest rate decision. Standard priors are shown to be associated with highly unrealistic judgmental decisions. Second, judgmental interest rate decisions are directly provided by the decision maker and incorporated into a formal statistical decision rule using frequentist procedures. When the observed interest rates are interpreted as judgmental decisions, they are found to be consistent with DSGE ...
Working Papers , Paper 202014

Report
Robust inference in models identified via heteroskedasticity

Identification via heteroskedasticity exploits differences in variances across regimes to identify parameters in simultaneous equations. I study weak identification in such models, which arises when variances change very little or the variances of multiple shocks change close to proportionally. I show that this causes standard inference to become unreliable, outline two tests to detect weak identification, and establish conditions for the validity of nonconservative methods for robust inference on an empirically relevant subset of the parameter vector. I apply these tools to monetary policy ...
Staff Reports , Paper 876

Working Paper
A Bias-Corrected Method of Moments Approach to Estimation of Dynamic Short-T Panels

This paper contributes to the GMM literature by introducing the idea of self-instrumenting target variables instead of searching for instruments that are uncorrelated with the errors, in cases where the correlation between the target variables and the errors can be derived. The advantage of the proposed approach lies in the fact that, by construction, the instruments have maximum correlation with the target variables and the problem of weak instrument is thus avoided. The proposed approach can be applied to estimation of a variety of models such as spatial and dynamic panel data models. In ...
Globalization Institute Working Papers , Paper 327

Working Paper
Misspecification-robust inference in linear asset pricing models with irrelevant risk factors

We show that in misspecified models with useless factors (for example, factors that are independent of the returns on the test assets), the standard inference procedures tend to erroneously conclude, with high probability, that these irrelevant factors are priced and the restrictions of the model hold. Our proposed model selection procedure, which is robust to useless factors and potential model misspecification, restores the standard inference and proves to be effective in eliminating factors that do not improve the model's pricing ability. The practical relevance of our analysis is ...
FRB Atlanta Working Paper , Paper 2013-09

Working Paper
Tests of Conditional Predictive Ability: Some Simulation Evidence

In this note we provide simulation evidence on the size and power of tests of predictive ability described in Giacomini and White (2006). Our goals are modest but non-trivial. First, we establish that there exist data generating processes that satisfy the null hypotheses of equal finite-sample (un)conditional predictive ability. We then consider various parameterizations of these DGPs as a means of evaluating the size and power properties of the proposed tests. While some of our results reinforce those in Giacomini and White (2006), others do not. We recommend against using the fixed scheme ...
Working Papers , Paper 2019-11

Working Paper
Tests of Equal Accuracy for Nested Models with Estimated Factors

In this paper we develop asymptotics for tests of equal predictive ability between nested models when factor-augmented regression models are used to forecast. We provide conditions under which the estimation of the factors does not affect the asymptotic distributions developed in Clark and McCracken (2001) and McCracken (2007). This enables researchers to use the existing tabulated critical values when conducting inference. As an intermediate result, we derive the asymptotic properties of the principal components estimator over recursive windows. We provide simulation evidence on the finite ...
Working Papers , Paper 2015-25

Working Paper
Too Good to Be True? Fallacies in Evaluating Risk Factor Models

This paper is concerned with statistical inference and model evaluation in possibly misspecified and unidentified linear asset-pricing models estimated by maximum likelihood and one-step generalized method of moments. Strikingly, when spurious factors (that is, factors that are uncorrelated with the returns on the test assets) are present, the models exhibit perfect fit, as measured by the squared correlation between the model's fitted expected returns and the average realized returns. Furthermore, factors that are spurious are selected with high probability, while factors that are useful are ...
FRB Atlanta Working Paper , Paper 2017-9

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