TY - JOUR

T1 - Nonparametric estimation of infinite order regression and its application to the risk-return tradeoff

AU - Hong, Seok Young

AU - Linton, Oliver

PY - 2020/12/1

Y1 - 2020/12/1

N2 - This paper studies nonparametric estimation of the infinite order regression E(Ytk|Ft−1), k∈Z with stationary and weakly dependent data. We propose a Nadaraya–Watson type estimator that operates with an infinite number of conditioning variables. We propose a bandwidth sequence that shrinks the effects of long lags, so the influence of all conditioning information is modelled in a natural and flexible way, and the issues of omitted information bias and specification error are effectively handled. We establish the asymptotic properties of the estimator under a wide range of static and dynamic regressions frameworks, thereby allowing various kinds of conditioning variables to be used. We establish pointwise/uniform consistency and CLTs. We show that the convergence rates are at best logarithmic, and depend on the smoothness of the regression, the distribution of the marginal regressors and their dependence structure in a non-trivial way via the Lambert W function. We apply our methodology to examine the intertemporal risk-return relation for the aggregate stock market, and some new empirical evidence is reported. For the S&P 500 daily data from 1950 to 2017 using our estimator we report an overall positive risk-return relation. We also find evidence of strong time variation and counter-cyclical behaviour in risk aversion. These conclusions are possibly attributable to the allowance of further flexibility and the inclusion of otherwise neglected information in our method.

AB - This paper studies nonparametric estimation of the infinite order regression E(Ytk|Ft−1), k∈Z with stationary and weakly dependent data. We propose a Nadaraya–Watson type estimator that operates with an infinite number of conditioning variables. We propose a bandwidth sequence that shrinks the effects of long lags, so the influence of all conditioning information is modelled in a natural and flexible way, and the issues of omitted information bias and specification error are effectively handled. We establish the asymptotic properties of the estimator under a wide range of static and dynamic regressions frameworks, thereby allowing various kinds of conditioning variables to be used. We establish pointwise/uniform consistency and CLTs. We show that the convergence rates are at best logarithmic, and depend on the smoothness of the regression, the distribution of the marginal regressors and their dependence structure in a non-trivial way via the Lambert W function. We apply our methodology to examine the intertemporal risk-return relation for the aggregate stock market, and some new empirical evidence is reported. For the S&P 500 daily data from 1950 to 2017 using our estimator we report an overall positive risk-return relation. We also find evidence of strong time variation and counter-cyclical behaviour in risk aversion. These conclusions are possibly attributable to the allowance of further flexibility and the inclusion of otherwise neglected information in our method.

U2 - 10.1016/j.jeconom.2020.03.009

DO - 10.1016/j.jeconom.2020.03.009

M3 - Journal article

VL - 219

SP - 389

EP - 424

JO - Journal of Econometrics

JF - Journal of Econometrics

SN - 0304-4076

IS - 2

ER -