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Activity Number: 109 - Time Series and Forecasting
Type: Topic Contributed
Date/Time: Monday, July 30, 2018 : 8:30 AM to 10:20 AM
Sponsor: Business and Economic Statistics Section
Abstract #330032 Presentation
Title: Monotonic Effects of Characteristics on Returns
Author(s): Jared Fisher* and Carlos Carvalho
Companies: University of Texas McCombs School of Business and University of Texas
Keywords: time-series; monotonic splines; firm characteristics

Using standard linear regression to describe the cross-section of expected returns implies that the relationships between firm characteristics and returns are both linear and stationary. While this is historically a common practice, finance literature now suggests that these relationships are nonlinear and/or nonstationary. We submit that these effects should also be monotonic. To this end, we present a Bayesian time-dynamic, additive quadratic spline model that can constrain individual splines to be monotonic. This model allows us to see the relationships that characteristics have with returns while controlling for many other covariates. Thus, these relationships can be evaluated for linearity, stationarity, and monotonicity. We present several of these relationships for examination.

Authors who are presenting talks have a * after their name.

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