Hypothesis Testing in Predictive Regressions

We propose a new hypothesis testing method for multi-predictor regressions with finite samples, where the dependent variable is regressed on lagged variables that are autoregressive. It is based on the augmented regression method (ARM; Amihud and Hurvich (2004)), which produces reduced-bias coefficients and is easy to implement. The method's usefulness is demonstrated by simulations and by an empirical example, where stock returns are predicted by dividend yield and by bond yield spread. For single-predictor regressions, we show that the ARM outperforms bootstrapping and that the ARM performs better than Lewellen's (2003) method in many situations