Journal of Econometrics

Available online 4 July 2022

Robust inference with stochastic local unit root regressors in predictive regressions

Yanbo Liu^a Peter C.B.Phillips^bcde

^aSchool of Economics, Shandong University, 27 Shanda Nanlu, Jinan, Shandong, 250100, PR China

^bYale University, United States of America

^cUniversity of Auckland, New Zealand

^dUniversity of Southampton, United Kingdom

^eSingapore Management University, Singapore

This paper explores predictive regression models with stochastic unit root (STUR) components and robust inference procedures that encompass a wide class of persistent and time-varying stochastically nonstationary regressors. The paper extends the mechanism of endogenously generated instrumentation known as IVX, showing that these methods remain valid for short and long-horizon predictive regressions in which the predictors have STUR and local STUR (LSTUR) generating mechanisms. Both mean regression and quantile regression methods are considered. The asymptotic distributions of the IVX estimators are new and require some new methods in their derivation. The distributions are compared to previous results and, as in earlier work, lead to pivotal limit distributions for Wald testing procedures that remain robust for both single and multiple regressors with various degrees of persistence and stochastic and fixed local departures from unit roots. Numerical experiments corroborate the asymptotic theory, and IVX testing shows good power and size control. The IVX methods are illustrated in an empirical application to evaluate the predictive capability of economic fundamentals in forecasting S&P 500 excess returns.