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Testing weak exogeneity in multiplicative error models

Luintel, Kul B. ORCID: and Xu, Yongdeng ORCID: 2017. Testing weak exogeneity in multiplicative error models. Quantitative Finance 17 (10) , pp. 1617-1630. 10.1080/14697688.2016.1274045

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Empirical market microstructure literature widely employs the non-linear and non-Gaussian Multiplicative Error Class of Models (MEMs) in modelling the dynamics of trading duration and financial marks. It routinely maintains the weak exogeneity of duration vis-à-vis marks in estimations. However, microstructure theory states that trade duration, volume and transaction prices are simultaneously determined. We propose Lagrange-multiplier (LM) tests for weak exogeneity for the MEMs. Our LM tests are extensions of the weak exogeneity tests applicable to VAR or VECM models with Gaussian distribution. Empirical assessments show that (i) weak exogeneity is widely rejected by the data in the MEMs and (ii) the failure of weak exogeneity seriously biases parameter estimates. We hope our tests will be of interest in future empirical applications.

Item Type: Article
Date Type: Published Online
Status: Published
Schools: Business (Including Economics)
Subjects: H Social Sciences > HA Statistics
H Social Sciences > HG Finance
Uncontrolled Keywords: Weak exogeneity, Multiplicative error model, LM test, Market microstructure
Publisher: Taylor & Francis (Routledge)
ISSN: 1469-7688
Date of First Compliant Deposit: 7 April 2017
Date of Acceptance: 9 December 2016
Last Modified: 06 Nov 2023 20:42

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