Specification Tests Robust to Multiple Instabilities
Job Market Paper
Awarded the Best Student Presentation Award at the 40th International Symposium on Forecasting.
Abstract: I develop a hypothesis test for model evaluation which is robust to time-variation in parameters. The proposed method can be applied in-sample and out-of-sample to any economic model based on moment conditions. In-sample, the test selects between two nested model specifications in the presence of parameter instabilities. Out-of-sample, the test can be used to evaluate the performance of model or judgmental forecasts robust to time-variation. The key feature of the proposed test is that it is particularly powerful in the presence of multiple shifts in parameters without imposing a specific form of time-variation. Further, the test statistic provides narrative evidence on which parts of the sample drive the rejection of the null hypothesis. Simulations show that the test is accurately sized in finite samples and is more powerful than tests assuming constant coefficients or a single break if the data-generating process exhibits multiple shifts in parameters. Using the proposed test, I document the presence of short-horizon predictability in the U.S. equity premium during the postwar period. I find evidence of predictability for a large set of variables once time-variation is taken into account. The test further provides evidence of heterogeneity in the location of predictability episodes across variables. The findings explain why traditional tests often fail to uncover predictability in the full sample and why studies that split the sample at different dates often arrive at conflicting results regarding the predictive ability of a wide class of variables.
To be presented at the European Winter Meetings of the Econometric Society 2020 and the Spanish Economic Association SAEe Meeting 2020. Presented at the 40th International Symposium on Forecasting, the 7th Barcelona GSE PhD Jamboree and the 8th SIdE Workshop for students in Econometrics and Empirical Economics.Read Job Market Paper