Testing for Monotonicity in Expected Asset Returns
37 Pages Posted: 7 Jun 2011 Last revised: 24 Jan 2013
Date Written: January 2013
Abstract
Many postulated relations in finance imply that expected asset returns strictly increase in an underlying characteristic. To examine the validity of such a claim, one needs to take the entire range of the characteristic into account, as is done in the recent proposal of Patton and Timmermann (2010). But their test is only a test for the direction of monotonicity, since it requires the relation to be monotonic from the outset: either weakly decreasing under the null or strictly increasing under the alternative. When the relation is non-monotonic or weakly increasing, the test can break down and falsely ‘establish’ a strictly increasing relation with high probability. We offer some alternative tests that do not share this problem. The behavior of the various tests is illustrated via Monte Carlo studies. We also present empirical applications to real data.
Keywords: Bootstrap, CAPM, Monotonicity tests, Non-monotonic relations
JEL Classification: C12, C58, G12, G14
Suggested Citation: Suggested Citation
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