Discussion paper

DP3671 In-Sample or Out-of-Sample Tests of Predictability: Which One Should We Use?

It is widely known that significant in-sample evidence of predictability does not guarantee significant out-of-sample predictability. This is often interpreted as an indication that in-sample evidence is likely to be spurious and should be discounted. In this Paper we question this conventional wisdom. Our analysis shows that neither data mining nor parameter instability is a plausible explanation of the observed tendency of in-sample tests to reject the no predictability null more often than out-of-sample tests. We provide an alternative explanation based on the higher power of in-sample tests of predictability. We conclude that results of in-sample tests of predictability will typically be more credible than results of out-of-sample tests.

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Citation

Kilian, L and A Inoue (2002), ‘DP3671 In-Sample or Out-of-Sample Tests of Predictability: Which One Should We Use?‘, CEPR Discussion Paper No. 3671. CEPR Press, Paris & London. https://cepr.org/publications/dp3671