Testing for Common Conditionally Heteroskedastic Factors

Authors

  • Prosper Dovonon,

    1. Dept. of Economics, Concordia University, 1455 de Maisonneuve Blvd. West, Montreal, Quebec, H3G 1M8 Canada, and CIRANO, and CIREQ; prosper.dovonon@concordia.ca
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  • Eric Renault

    1. Dept. of Economics, Brown University, 64 Waterman Street, Providence, RI 02912, U.S.A., and CIRANO, and CIREQ; Eric_Renault@brown.edu
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    • We would like to thank Manuel Arellano, Yves Atchadé, Valentina Corradi, Giovanni Forchini, Sílvia Gonçalves, and Enrique Sentana for helpful comments. We are also grateful to four anonymous referees and a co-editor for many valuable suggestions. Financial support from FQRSC is gratefully acknowledged.


Abstract

This paper proposes a test for common conditionally heteroskedastic (CH) features in asset returns. Following Engle and Kozicki (1993), the common CH features property is expressed in terms of testable overidentifying moment restrictions. However, as we show, these moment conditions have a degenerate Jacobian matrix at the true parameter value and therefore the standard asymptotic results of Hansen (1982) do not apply. We show in this context that Hansen's (1982) J-test statistic is asymptotically distributed as the minimum of the limit of a certain random process with a markedly nonstandard distribution. If two assets are considered, this asymptotic distribution is a fifty–fifty mixture of χ2H−1 and χ2H, where H is the number of moment conditions, as opposed to a χ2H−1. With more than two assets, this distribution lies between the χ2Hp and χ2H (p denotes the number of parameters). These results show that ignoring the lack of first-order identification of the moment condition model leads to oversized tests with a possibly increasing overrejection rate with the number of assets. A Monte Carlo study illustrates these findings.

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