Estimation with Errors in Variables via the Characteristic Function

Abstract Errors in variables in linear regression continue to be a significant empirical issue in financial econometrics. We propose using the characteristic function (CF) to obtain estimates for linear models with errors in the variables. By assuming that the explanatory variable follows a flexible...

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Bibliographic Details
Published in:Journal of financial econometrics 2023-06, Vol.21 (3), p.616-650
Main Authors: Malloch, H, Philip, R, Satchell, S
Format: Article
Language:English
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Summary:Abstract Errors in variables in linear regression continue to be a significant empirical issue in financial econometrics. We propose using the characteristic function (CF) to obtain estimates for linear models with errors in the variables. By assuming that the explanatory variable follows a flexible double gamma distribution, we obtain closed-form expressions for the analytic CF of the data generating process. We show that our method performs well relative to existing techniques that address error-in-variables (EIVs) through simulations. We further extend our CF technique to a multivariate setting where it continues to produce accurate estimates. We illustrate the performance of our procedure by estimating the capital asset pricing model and a two-factor model.
ISSN:1479-8409
1479-8417
DOI:10.1093/jjfinec/nbab011