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UBC Theses and Dissertations

Essays on forecast evaluation and model estimation in financial markets Tong, Guoshi


This thesis is comprised of three essays. In the first and second essays, I examine the welfare value of return predictors in financial markets when investors possess only limited historical data. The first essay focuses on the US Treasury bond market where time series variation in the expected return is forecastable by yield curve and macroeconomic variables. The second essay shifts attention to the US stock market where cross-sectional variation in the expected return is predictable by the underlying firms' characteristics. Using monthly US data, I estimate the utility benefit of various return predictors in either the bond or stock market through a structural approach of forecast evaluation. I consider both parametric and non-parametric portfolio policies and conduct both unconditional and conditional evaluations. I find that return predictors are generally hard to exploit with limited data. Incorporating return predictors renders the portfolio strategy more sensitive to estimation errors and instability in forecast relations. The resultant negative effect on portfolio returns and welfare is not dominated by the information value of predictors. The third essay discusses the estimation of the Cox-Ingersoll-Ross interest rate model. I propose a new likelihood-based methodology that uses marginal Metropolis Hasting algorithm with particle-filter based simulated-likelihood placed in each of the iterations. The benefit of this Bayesian approach is that it bypasses the need to compute exact likelihood functions, and its validity rests upon a recent development in Bayesian statistical theory. To mitigate the inefficiency in standard bootstrap filters due to peaky measurement density of the CIR model, I design an approximated conditional optimal filter to account for the informativeness of current yields and reduce the variance of particle weights. For typical parameter values, performance is shown to be satisfactory.

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