A Simple Out-of-Sample Test of Predictability against the Random Walk Benchmark

Pablo Pincheira, Nicolas Hardy, Andrea Bentancor

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

Abstract

We show that a straightforward modification of a trading-based test for predictability displays interesting advantages over the Excess Profitability (EP) test proposed by Anatolyev and Gerco when testing the Driftless Random Walk Hypothesis. Our statistic is called the Straightforward Excess Profitability (SEP) test, and it avoids the calculation of a term that under the null of no predictability should be zero but in practice may be sizable. In addition, our test does not require the strong assumption of independence used to derive the EP test. We claim that dependence is the rule and not the exception. We show via Monte Carlo simulations that the SEP test outperforms the EP test in terms of size and power. Finally, we illustrate the use of our test in an empirical application within the context of the commodity-currencies literature.

Original languageEnglish
Article number228
JournalMathematics
Volume10
Issue number2
DOIs
StatePublished - 1 Jan 2022
Externally publishedYes

Keywords

  • Asset returns
  • Commodities
  • Exchange rates
  • Forecast evaluation
  • Hypothesis testing
  • Random walk

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