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The small sample properties of tests of the expectations hypothesis: a Monte Carlo investigation
Author(s) -
Garganas Eugenie,
Hall Stephen G.
Publication year - 2011
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/ijfe.422
Subject(s) - econometrics , economics , monte carlo method , wald test , ordinary least squares , sample (material) , autoregressive model , statistic , sample size determination , statistical hypothesis testing , mathematics , statistics , physics , thermodynamics
In this paper, we extend results from the finance literature that explores small sample bias, due to persistent variables, in tests of present value asset pricing models. Using a Monte Carlo simulation approach, we investigate the finite sample behaviour of standard tests of the expectations hypothesis (EH) of the term structure, when interest rates are increasingly persistent. We document bias for the ‘perfect foresight spread’ regression and find that the variance bound statistic strongly tends to favour the EH when persistence is high. In a vector autoregression (VAR) framework, the Wald test and the slope of the ordinary least squares test using the ‘VAR‐theoretical spread’ are strongly biased. Copyright © 2010 John Wiley & Sons, Ltd.