More Powerful Portfolio Approaches to Regressing Abnormal Returns on Firm‐Specific Variables for Cross‐Sectional Studies

More Powerful Portfolio Approaches to Regressing Abnormal Returns on Firm‐Specific Variables... ABSTRACT OLS regression ignores both heteroscedasticity and cross‐correlations of abnormal returns; therefore, tests of regression coefficients are weak and biased. A Portfolio OLS (POLS) regression accounts for correlations and ensures unbiasedness of tests, but does not improve their power. We propose Portfolio Weighted Least Squares (PWLS) and Portfolio Constant Correlation Model (PCCM) regressions to improve the power. Both utilize the heteroscedasticity of abnormal returns in estimating the coefficients; PWLS ignores the correlations, while PCCM uses intra‐and inter‐industry correlations. Simulation results show that both lead to more powerful tests of regression coefficients than POLS. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

More Powerful Portfolio Approaches to Regressing Abnormal Returns on Firm‐Specific Variables for Cross‐Sectional Studies

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Publisher
Wiley
Copyright
1992 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1992.tb04697.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT OLS regression ignores both heteroscedasticity and cross‐correlations of abnormal returns; therefore, tests of regression coefficients are weak and biased. A Portfolio OLS (POLS) regression accounts for correlations and ensures unbiasedness of tests, but does not improve their power. We propose Portfolio Weighted Least Squares (PWLS) and Portfolio Constant Correlation Model (PCCM) regressions to improve the power. Both utilize the heteroscedasticity of abnormal returns in estimating the coefficients; PWLS ignores the correlations, while PCCM uses intra‐and inter‐industry correlations. Simulation results show that both lead to more powerful tests of regression coefficients than POLS.

Journal

The Journal of FinanceWiley

Published: Dec 1, 1992

References

  • A portfolio approach to estimating the average correlation coefficient
    Aneja, Aneja; Chandra, Chandra; Gunay, Gunay
  • Are betas best?
    Elton, Elton; Gruber, Gruber; Urich, Urich
  • Portfolio selection
    Markowitz, Markowitz

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