TY - JOUR
AU - Frankel,Jeffrey A.
AU - Stock,James H.
TI - A Relationship Between Regression Tests and Volatility Tests of Market ncy
JF - National Bureau of Economic Research Working Paper Series
VL - No. 1105
PY - 1987
Y2 - October 1987
UR - http://www.nber.org/papers/w1105
L1 - http://www.nber.org/papers/w1105.pdf
N1 - Author contact info:
Jeffrey A. Frankel
Harvard Kennedy School
Harvard University
79 JFK Street
Cambridge, MA 02138
Tel: 617/496-3834
Fax: 617/496-5747
E-Mail: jeffrey_frankel@harvard.edu
James H. Stock
Department of Economics
Harvard University
Littauer Center M27
Cambridge, MA 02138
Tel: 617/496-0502
Fax: 617/495-7730
E-Mail: James_Stock@harvard.edu
AB - Volatility tests are an alternative to regression tests for evaluating the joint null hypothesis of market efficiency and risk neutrality. Acomparison of the power of the two kinds of tests depends on what the alternative hypothesis is taken to be. By considering tests based on conditional volatility bounds, we show that if the alternative is that one could"beat the market" using a linear combination of known variables, then the regression tests are at least as powerful as the conditional volatility tests.If the application is to spot and forward markets, then the most powerful conditional volatility test turns out to be equivalent to the analogous regression test in terms of asymptotic power. In other applications,the volatility test will be less powerful than regression tests against our chosen alternative. However, these results are not inconsistent with the observation that volatility tests may be more powerful against other alternative hypoth-eses, such as that risk-averse investors are rationally maximizing the present discounted utility of future consumption,with a time-varying discount rate.
ER -