Working Papers, Department of Economics, Lund University
No 2000:18:
The Compass Rose Pattern of the Stock Market: How Does it Affect Parameter Estimates, Forecasts, and Statistical Tests?
Henrik Amilon ()
and Hans Byström ()
Abstract: A "compass rose" pattern sometimes appears when stock
returns are plotted against themselves with a one-day lag, since stock
prices move in discrete steps. In this paper, we perform a Monte Carlo
study on simulated stock price series rounded in different ways to mirror
the behavior of stocks on the Stockholm Stock Exchange. We find AR-GARCH
parameter estimates to be affected by the discreteness imposed by rounding.
Based on the compass rose and the discreteness, we investigate,
theoretically and empirically, different possibilities of improving
predictions of stock returns. The distributions of the BDS test as well as
Savit and Green's dependability index are also influenced by the compass
rose pattern. However, throughout the paper, we must impose unrealistically
heavy rounding of the stock prices to find significant effects on our
estimates, forecasts, and statistical tests.
Keywords: discrete prices; GARCH; forecasts; correlation integral statistics; (follow links to similar papers)
JEL-Codes: C15; C22; G19; (follow links to similar papers)
22 pages, November 6, 2000
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