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

Research output: Contribution to journalArticlepeer-review

Abstract

The literature has recently proposed a new type of tests for the Efficient Market Hypothesis based on Permanent-Transitory Component Models. We compare the power of these statistics with conventional tests based on linear regressions. Simulation results suggest that the former dominate the latter for a wide 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 by the size distortions and reduced power which affect the statistics based on linear regressions.

Original languageEnglish
Pages (from-to)142-153
Number of pages12
JournalInternational Review of Financial Analysis
Volume47
DOIs
Publication statusPublished - 1 Oct 2016
Externally publishedYes

Keywords

  • Efficient Markets Hypothesis
  • MC simulations
  • Permanent-Transitory Component Models

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