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Keywords:

  • linear regression;
  • omitted variables;
  • control variables
  • C10;
  • G10

Abstract

This paper discusses the two different contradicting philosophies for testing models in financial economics (asset pricing, corporate finance, and market-microstructure) using linear regression. We synthesize these two contradicting approaches, document the errors that may occur in the existing estimation methodologies, and suggest a modified procedure that avoids these errors.