Pitfalls and Possibilities in Predictive Regression
Financial theory and econometric methodology both struggle in formulating models that are logically sound in reconciling short run martingale behaviour for ﬁnancial assets with predictable long run behavior, leaving much of the research to be empirically driven. The present paper overviews recent contributions to this subject, focussing on the main pitfalls in conducting predictive regression and on some of the possibilities oﬀered by modern econometric methods. The latter options include indirect inference and techniques of endogenous instrumentation that use convenient temporal transforms of persistent regressors. Some additional suggestions are made for bias elimination, quantile crossing amelioration, and control of predictive model misspeciﬁcation.
Phillips, Peter C.B., "Pitfalls and Possibilities in Predictive Regression" (2015). Cowles Foundation Discussion Papers. 2438.