ECON 546 PROJECT FINAL REPORT

GARCH MODEL MONTE CARLO TESTS AND BOOTSTRAP BIAS CORRECTION:

AN APPLICATION USING S&P 500 DAILY RETURNS

Monica Mow

ECON 546
Themes in Econometrics
University of Victoria
April 9, 2018
 ABSTRACT

This paper uses simulation-based techniques to obtain the null distribution for ARCH LM

tests of conditional heteroscedasticity to analyze the performance of the limiting null distribution

in finite samples. I estimate a GARCH model using daily S&P 500 returns to obtain Monte Carlo

LM test statistics. The simulated test statistics are compared to the sample LM test statistic to

generate Monte Carlo p-values. The Monte Carlo p-value obtained from the procedure at 199

replications is 0.25, much lower than the 0.48 associated with the sample LM statistic. This

result reveals the implications of statistical inference in finite samples. I also provide a bias-

corrected estimate for the GARCH model conditional mean return by bootstrapping the bias. The

bias was found to be -0.02%, indicating that the maximum likelihood estimator is fairly biased.

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1. Introduction

Modeling stock returns has confounded finance researchers for quite some time. Common

models include constant expected return models (mean models) or market models such as the

capital asset pricing model (CAPM). Stock returns exhibit what financial econometricians call

“volatility clustering” or “conditional heteroscedasticity”. In his 1963 paper, Mandelbrot

described volatility clustering as “large changes tend[ing] to be followed by large changes, of

either sign, and small changes tend[ing] to be followed by small changes.” As time series

variables that exhibit autocorrelation are modeled with AR and/or MA processes, so too are their

variances; the series can be estimated using an ARCH or GARCH process to treat the

autocorrelation in the variance. Before modeling any time series variable using an ARCH or

GARCH process, Engle’s (1982) Lagrange Multiplier (LM) test should be employed to test for

conditional heteroscedasticity.

In this paper, I model daily returns of the S&P 500 index using a GARCH(1,2) expected

return model and implement Dwass (1957) and Barnard’s (1963) Monte Carlo test technique to

calculate p-values for the ARCH LM test at a varying number of replications. I also provide a

bias-corrected estimate of the mean return generated from the GARCH(1,2) model using

bootstrap methods. The results shown in this paper reveal the significant changes in the p-value

associated with the LM test-statistic and the estimate for the mean return after correcting for bias.

This highlights for financial econometricians the finite sample properties of the LM test and the

related implications. This research also highlights the potential biasedness of the maximum

likelihood estimator even when using a fairly large sample.

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2. Literature Review

In his 1982 paper, Engle introduces the ARCH model and ARCH Lagrange Multiplier test

based on the autocorrelation of the squared OLS residuals. Unlike traditional models, Engle

assumes a non-constant one-period forecast variance. Past attempts to model the mean and

variance of UK inflation proved to be difficult. Estimating the variance of macroeconomic

variables is of importance since economic theory suggests that agents respond to higher moments

of economic variables than just the mean. For example, in portfolio theory, the mean and

variance are used as measures for return and risk, which determine portfolio allocation decisions.

Engle allows for the variance to change stochastically and finds that UK inflation has significant

ARCH effects. He finds that specifying models with disturbances that follow an ARCH process

result in better-performing least squares models and more realistic forecast variances. Engle also

shows that maximum likelihood estimation is more efficient than OLS when disturbances follow

an ARCH process.

Another empirical paper by French, Schwert & Stambaugh (1987) examines the relationship

between the expected risk premium (excess return) on common stocks and predictable volatility

using a market model. The authors use a GARCH-M model on S&P 500 data but do not conduct

any ARCH LM tests. They find a positive relationship between excess returns and predictable

volatility. They also find that the GARCH-M model produces similar results to an ARIMA

model of ex ante risk premiums and volatility.

This paper implements a Monte Carlo test procedure similar to Dufour, Khalaf, Bernard &

Genest (2004). However, Dufour et al. (2004) conduct a pure simulation-based procedure and do

not use actual data. The authors conduct Monte Carlo experiments under specific data generating

processes for the disturbances to analyze the properties of finite sample tests for

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heteroscedasticity and ARCH effects. To analyze the power of the tests, the authors obtain

rejection percentages at a 5% nominal size using 10,000 replications. They find that Engle’s test

is undersized, which leads to substantial power losses, and that the size distortions are larger

when non-normal errors are used in the DGPs. One of the most important findings in this paper

is that the Monte Carlo tests yield significant power gains, especially with non-normal errors.

My project contributes to the literature by simulating the finite sample null distribution

through Monte Carlo procedures to analyze the properties of finite sample ARCH LM tests.

Unlike the aforementioned papers, I conduct the Monte Carlo test procedure using actual data

and also obtain bias-corrected maximum likelihood estimates for the mean return by

bootstrapping the bias of the estimate.

3. Data, Summary Stats and Graphical Evidence

3.1. Data description

Daily index prices for the S&P 500 are obtained for the period January 3, 1950 to March 7,

2018. There are a total of 17,155 observations that include trading days only. The data were

retrieved from Yahoo! Finance1. Daily returns are constructed by taking the first difference of

the log price series. Figure 1 below plots the daily returns and Figure 2 plots the daily squared

returns. Summary statistics are provided in Table 1 below. The mean daily return over the

sample period is 0.03% with a standard deviation of 0.97% and a variance of 0.93%-squared.

Daily returns over the sample range from a low of -22.9% and a high of 10.96%. The mean

squared daily return is 0.93% with a standard deviation of 5.03% and a variance of 25.30%-

squared.

As is evident in Figure 1, the biggest one-day decline in the S&P 500 of -22.9% occurred on

October 19, 1987, now referred to as “Black Monday.” Other periods of increased volatility
1
Data source: https://ca.finance.yahoo.com/quote/%5EGSPC/history?p=%5EGSPC

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include the late-1990s and early-2000s, which coincide with the dot-com bubble. The most

recent period of increased volatility occurred during the global financial crisis in late-2008.

Figure 2 plots the daily squared returns, which further highlights the periods of increased

volatility. The spikes in volatility in 1987, the late-1990s, early-2000s and in 2008 are also

evident in this figure.

Table 1 – Summary statistics of daily S&P 500 returns (%)

Std
Mean Dev Var Min Max
Return 0.03 0.97 0.93 -22.90 10.96
Return2 0.93 5.03 25.30 0.00 524.40

Figure 1 – Daily returns of S&P 500

S&P 500 Daily Return (%)

15

10

-5

-10

-15

-20

-25
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

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 Figure 2 – Daily squared returns of S&P 500

S&P 500 Daily Squared Return (%)

600

500

400

300

200

100

0
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

3.2. Evidence of conditional heteroscedasticity

Figure 3 shows the correlogram of the daily returns, while Figure 4 shows the squared daily

returns. At first glance, the returns appear to be not autocorrelated as the correlogram does not

show slow-decaying autocorreation functions (ACFs). The partial autocorrelation functions

(PACFs) also do not show any large spikes, indicating that there is no autocorrelation in the

series. The latter graph of the squared daily returns is presented in order to provide evidence for

conditional heteroscedasticity (volatility clustering). The ACFs of the squared returns exhibit a

slow decay, indicating their autoregressive behaviour. The PACFs do not show as much of a

slow-decaying pattern as the ACFs but tend to spike at specific lag orders. This indicates that,

after controlling for a specific lag, all other lags exhibit autoregressive behaviour, which hints at

a moving average component in the series.

It should be noted that for the returns, the Ljung-Box Q-statistics are large and their

associated p-values are zero, indicating a rejection of the null hypothesis that there is no

autocorrelation up to that specific lag. Thus, we cannot say that the returns are not

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autocorrelated. However, there is an even stronger rejection of the null hypothesis of no

autocorrelation in the squared returns since the Q-statistics range in the thousands after lag order

1, while they were less than 100 for the returns themselves.

Figure 3 – Correlogram of S&P 500 daily returns

Figure 4 – Correlogram of squared S&P 500 daily returns

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4. Methodology

4.1. GARCH(1,2) constant expected return model

Since the squared returns exhibit a large degree of autoregressive behaviour, we could model

the series with multiple AR terms as independent variables. Mills and Markellos (2008) control

for the high number of AR terms by including an MA(1) process as an independent variable, and

model the series as a GARCH(1,2). This is consistent with the literature that suggests modeling

series that have slow-decaying ACFs and spikes in PACFs as GARCH processes (Penn State

University, n.d.). Originally, an ARCH(1) model was specified but it did not adequately treat the

autocorrelation in the error variances. This led to a zero p-value associated with the LM-statistic

for each replication, and consequently a zero Monte Carlo p-value for every different number of

replications, an uninteresting result. Instead, I follow Mills and Markelos (2008) and estimate a

GARCH(1,2) model on S&P 500 daily returns, except I exclude the MA(1) term as an

independent variable for simplicity.

The sample regression is a GARCH(1,2) constant expected return model and regresses the

daily return on a constant as follows:

𝑟𝑡 = 𝜇 + 𝜖𝑡

That is, the daily return is composed of a constant non-zero mean, 𝜇, and a disturbance, 𝜖𝑡 ,

which is the product of a time-dependent standard deviation and a stochastic process i.e. a white

noise term:

𝜖𝑡 = 𝜎𝑡 𝑒𝑡

𝑒𝑡 ~ 𝑤ℎ𝑖𝑡𝑒 𝑛𝑜𝑖𝑠𝑒(0, 1)

The variance of the daily returns is:

𝑉𝑎𝑟(𝑟𝑡 ) = 𝑉𝑎𝑟(𝜖𝑡 ) = 𝜎𝑡2

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The original ARCH(1) model specifies the variance equation as:
2
𝜎𝑡2 = 𝛼0 + 𝛼1 𝜖𝑡−1

and the GARCH(1,2) model specifies the variance equation as:

2 2 2
𝜎𝑡2 = 𝛼0 + 𝛼1 𝜖𝑡−1 + 𝛽1 𝜎𝑡−1 + 𝛽2 𝜎𝑡−2

4.2. Monte Carlo test

The Monte Carlo test technique begins by estimating the sample regression, in this case, the

GARCH(1,2) mean model of daily returns. Engle’s ARCH LM test is then performed post

estimation, where the sample LM test-statistic, LM0 is obtained. The standard error of the

regression, 𝜎̂, is obtained to generate a parametric random sample of residuals for each

replication j, j = 1, 2, …, J:

𝑣𝑡 ~𝑁(0, 𝜎̂ 2 )

For each replication, a series of new returns, 𝑛𝑒𝑤𝑟𝑡 is generated using the estimated mean return

from the model and adding it to the new series of residuals:

𝑛𝑒𝑤𝑟𝑡 = 𝜇̂ + 𝑣𝑡

The J return series are used to estimate the GARCH(1,2) model J times. Obtaining the ARCH

LM test-statistic programmatically in EViews requires a few steps. First, the residuals and the

variance from the regression are obtained, where the variance is used to scale the residuals to

create a standardized (weighted) residual series:

𝑒̂
𝑒̃ =
√𝜎̃ 2

Second, the weighted-residuals are squared and used in the following auxiliary regression to test

for conditional heteroscedasticity:

2 2 2
𝑒̃ 2 = 𝛽0 + 𝛽1 𝑒̃𝑡−1 + 𝛽2 𝑒̃𝑡−2 + ⋯ + 𝛽12 𝑒̃𝑡−12

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Following Mills and Markellos (2008), I use a constant and 12 lags of the residual as

independent variables. Finally, the ARCH LM test statistic is obtained by multiplying the

number of observations by the R-squared in the auxiliary regression, and is denoted LMj.

To obtain a Monte Carlo p-value, I count the number of times LMj is greater than LM0:
𝐽

𝑐𝑜𝑢𝑛𝑡 = ∑ 𝐼(𝐿𝑀𝑗 ≥ 𝐿𝑀0 )

𝑗=1

The Monte Carlo p-value is then:

𝑐𝑜𝑢𝑛𝑡 + 1
𝑝𝑀𝐶 =
𝐽+1

According to Dufour (2005), implementing permutation tests has the desirable feature that exact

(randomized) tests can be obtained for statistics with intractable finite sample distributions that

can be simulated, as long as there are no nuisance parameters. Dwass (1957) proved that the

choice of count will result in an exact test of size k/Q for a chosen significance level. To achieve

this result, the count must be an integer, and therefore the number of permutations, or

replications, J, must be chosen to satisfy:

𝑐𝑜𝑢𝑛𝑡 = 𝑘 × (𝐽 + 1)/𝑄 − 1,

which implies that we must pick J to satisfy:

𝛼 × (𝐽 + 1)

For example, for a significance level of 5%, J can be as low as 19. Dwass showed that the

number of replications achieves size control as long as the above is satisfied, and does not impact

the validity of the test, only the power. Increasing J will increase power but power gains at very

large values of J are small (Dufour, 2005).

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 4.3. Bootstrap bias correction

I also provide bias-corrected estimates of the mean return from the GARCH(1,2) model by

bootstrapping the bias. The first step is to estimate the GARCH model, save the residuals and the

estimated mean return, 𝜇̂ . In the usual bias formula, 𝜇̂ is treated as a pseudo-population

parameter, 𝜇𝑛 , while the expected value of the estimator is the average of all the mean returns

obtained in each replication:

𝑏𝑖𝑎𝑠 = 𝐸(𝜇̂ 𝑛 ) − 𝜇𝑛

𝑏𝑖𝑎𝑠𝑏𝑜𝑜𝑡 = 𝜇̅𝐵 − 𝜇𝑛

1
where 𝜇̅𝐵 = (𝐵) ∑𝐵𝑏=1 𝜇𝑛,𝑏

and B is the number of replications. Similar to the Monte Carlo test procedure, a new series

of returns is generated using the estimated mean return and a random sample of residuals. For

each replication, I conduct a nonparametric resample of the regression residuals (with

replacement). B estimations of the GARCH model are performed, which regresses the new return

series on a constant. The estimated mean returns from the B regressions are the 𝜇𝑛,𝑏 in the third

equation, and are averaged to obtain 𝜇̅𝐵 . The bias-corrected mean return is then:

𝜇𝑏𝑜𝑜𝑡 = 𝜇𝑛 − 𝑏𝑖𝑎𝑠𝑏𝑜𝑜𝑡 = 2𝜇𝑛 − 𝜇̅𝐵

5. Results and Discussion

5.1. GARCH(1,2) model output

As can be seen in Table 2 below, the estimated conditional mean daily return is 0.049%. This

is quite different from the unconditional mean of 0.03% reported in Table 1. The reported

standard error is 0.0000519 which leads to a Z-statistic of 9.49 and an associated p-value of 0.

Thus, we would reject the null of no significance at all conventional levels. The variance

equation estimates indicate that the variance is adequately specified as a GARCH(1,2) process as

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can be seen in the second panel of the table. The estimate for the constant term is near zero,

while the one-period lagged squared residual term has a coefficient of 0.11. The Z-statistic on the

squared residual term is 35.08 with a p-value of zero, indicating that there are statistically

significant ARCH effects. The coefficients on the GARCH terms are 0.60 and 0.29 for lags of

one and two, respectively. Both have p-values of zero, indicating that there are statistically

significant GARCH effects. If there were no ARCH or GARCH effects, only the constant term

would be significant, and if there were only ARCH effects, only the constant and squared

residual terms would be significant.

Table 2: GARCH(1,2) model estimates for the mean return

Coefficient Std. Error Z-statistic P-value

Mean return (𝜇) 0.00049 5.19E-05 9.49 0.00
Variance Equation
Constant (𝛼0 ) 1.09E-06 8.48E-08 12.89 0.00
2
RESID(-1)^2 (𝜖𝑡−1 ) 0.11 0.0030 35.08 0.00
2
GARCH(-1) (𝜎𝑡−1 ) 0.60 0.047 12.72 0.00
2
GARCH(-2) (𝜎𝑡−2 ) 0.29 0.045 6.42 0.00
N 17,154
Adjusted R-squared -0.00041
S.E. of regression 0.0097
ARCH LM statistic 11.55
P-value 0.48

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 The reported sample LM statistic, which I denote LM0, is 11.55 with an associated p-value of

0.48. This value will be compared to each replication of the LM statistic, denoted LMj, in the

Monte Carlo test method. Since the p-value is greater than the conventional significance levels,

we cannot reject the null and can conclude that the GARCH(1,2) specification adequately treats

the conditional heteroscedasticity. The reported standard error of the regression, 0.0097, is used

in the parametric generation of new residuals in the Monte Carlo test procedure.

5.2. Monte Carlo test-statistics and p-values

I simulate Monte Carlo p-values at 19, 49, 99, 199 and 499 replications. As discussed in

Section 4.2, these number of replications satisfy Dwass’ (1957) criteria to obtain an exact test.

The results in Table 3 show that as the number of replications increases, the p-value decreases

until the number of replications reaches 199. The p-value is as high as 0.50 at 19 replications and

as low as 0.25 at 199 replications. These values are in contrast to the sample p-value of 0.48.

Nonetheless, we would still fail to reject the null hypothesis, and can conclude that the

GARCH(1,2) model adequately treats the conditional heteroscedasticity.

Table 3: Monte Carlo p-values

Monte
Number of Carlo p-
replications value
19 0.50
49 0.28
99 0.27
199 0.25
499 0.26
999 0.27

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 Figure 5 shows the distribution of the LM statistics for each number of replications (i.e. the

simulated finite sample null distribution). It is interesting to see how the chi-square distribution

becomes more evident as J increases. At higher values of J (i.e. greater than 19), the majority of

the LM statistics range between eight and ten, which may be quite different from the sample

value of 11.55.

Figure 5: Distribution of LM statistics at each number of replications

J = 19 J = 49
LM_STAT LM_STAT
.09 .12

.08
.10
.07

.06 .08

.05
Density

Density

.06
.04

.03 .04

.02
.02
.01

.00 .00
2 4 6 8 10 12 14 16 18 20 22 24 26 0 2 4 6 8 10 12 14 16 18 20 22 24 26

J = 99 J = 199
LM_STAT LM_STAT
.14 .12

.12
.10

.10
.08

.08
Density

Density

.06
.06

.04
.04

.02
.02

.00 .00
0 2 4 6 8 10 12 14 16 18 20 22 24 0 10 20 30 40 50 60 70 80 90

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 J = 499 J = 999
LM_STAT LM_STAT
.12 .10

.10
.08

.08
.06
Density

Density
.06

.04
.04

.02
.02

.00 .00
0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80 90 100 110 120

5.3. Bootstrap bias-corrected coefficients

A bias-corrected mean return is obtained by bootstrapping the estimator’s bias with 100 and

1,000 replications. The bias is -0.0199% at 100 replications and -0.0193% at 1,000 replications.

The resulting bias-corrected mean returns are 0.0691% and 0.0685%, respectively, indicating a

significant bias downwards of the estimated sample mean return of 0.0492%.

Table 4: Bootstrap bias-corrected mean return, bias, and expected mean return (%)

Number of
𝜇𝑏𝑜𝑜𝑡 𝑏𝑖𝑎𝑠𝑏𝑜𝑜𝑡 𝜇̅𝐵
replications
100 0.0691 -0.0199 0.0293
1,000 0.0685 -0.0193 0.03

5.4. Implications

The Monte Carlo LM tests produced significant differences between the sample p-value and

the Monte Carlo p-values. At 199 replications the p-value was 0.25 compared to the sample

value of 0.48, a difference of 23 percentage points. This suggests that Engle’s LM test may lead

us to under-reject the null in finite sample sizes. This has negative consequences for modeling

time series that have ARCH effects; one might reject at higher significance levels than

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appropriate2, or fail to detect ARCH effects altogether. As Dufour et al. (2004) highlight, the

estimate for the conditional mean return can be inconsistent if one is unable to detect

misspecifications in the conditional variance equation.

There was also a significant difference between the sample mean daily return and its bias-

corrected counterpart. At 1,000 replications, the mean return was 0.0193 percentage points

higher than the 0.0492% sample estimate, which is almost 40% higher. On an annual return

basis, this difference is around 5 percentage points—the difference between 12% and 17%,

obtained by multiplying the mean daily return by 252 trading days. The consequence is that

conditional mean returns may be higher than the model predicts.

6. Conclusion

This paper obtains the finite sample null distribution of the ARCH LM statistic through

Monte Carlo simulations to reveal the poor approximation of the asymptotic null distribution in

finite samples. From the simulated LM statistics, Monte Carlo p-values are obtained at a varying

number of replications. A bias-corrected mean return is also obtained by bootstrapping the bias.

The significant difference between the sample p-value and the Monte Carlo p-value suggests

that employing the ARCH LM test in finite sample sizes can result in an under-rejection of the

null hypothesis of the presence of conditional heteroscedasticity. This could lead to inconsistent

conditional moment estimates in GARCH models, and result in inaccurate forecast variances,

which is undesirable for investors or policymakers who regularly conduct forecasts. For

empirical papers that use ARCH LM tests, it would be advisable to conduct Monte Carlo tests.

The estimate of the mean daily return from the GARCH(1,2) model was 0.0492%. After

correcting for the negative bias, this estimate increases to 0.0685% at 1,000 replications. This

2
For example, for a sample p-value of 7% and a Monte Carlo p-value of 2%, one would reject at the 10% level
when they should reject at the 5% level.

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reveals that even with fairly large samples, the maximum likelihood estimator is quite biased,

and this has the implication that average returns may be higher than what models predict.

This paper creates an opening for a fair amount of future research. The Monte Carlo test

procedure in this paper randomly generates residuals parametrically, which assumes that the

residuals are normally distributed with mean zero and standard deviation equal to the standard

error of the GARCH(1,2) regression. Further research could see how the results differ by either

generating the sample of residuals non-parametrically or by relaxing the normality assumption.

Like in Dufour et al. (2004) the residuals could take on a standard normal, chi-square, Student’s

t, or Cauchy distribution (i.e. Student’s t with one degree of freedom).

This paper could also be extended to look at the power of the test. Dufour et al. (2004)

analyze the power of the ARCH LM test but do not apply the procedure to actual data. One could

generate the new return series using a DGP that satisfies the alternative hypothesis of conditional

heteroscedasticity.

Other areas of future research could also re-specify the original model. The GARCH(1,2)

model is just one of several time series specifications. For example, one could instead model a

GARCH in mean (GARCH-M), a Threshold ARCH (TARCH), an Exponential GARCH

(EGARCH) or an Asymmetric Power ARCH (APARCH) process, which model the mean or

variance equations differently or put assumptions on the 𝜖𝑡 . Instead of estimating a simple

constant expected return model, one could estimate a CAPM model like French et al. (1986).

Finally, the methods employed here could also be applied to other datasets that exhibit

ARCH effects, such as exchange rates or inflation.

Page 18 of 22
Appendix

A1. Code from Monte Carlo test procedure

cd "\\home\mcmow\econ546\project\"

wfcreate(wf=main, page=undated) u 17155

' import data

import GSP.xlsx

' generate variables

genr log_price = log(price)
genr returns = log_price-log_price(-1)
genr returns_sq = returns^2

' some graphs

graph graph_returns.line returns
graph_returns.save(t=png, u=in, w=5, d=300) graph_returns

freeze(correl) returns.correl(12)
correl.save(t=png) \\home\mcmow\econ546\project\correl.png

freeze(correl_sq) returns_sq.correl(12)
correl_sq.save(t=png) \\home\mcmow\econ546\project\correl_sq.png

' set reps

scalar nrep=19
scalar count=0
rndseed 88888888

' **********************************************************
' ********** THE SAMPLE VALUE OF LM ***********
' **********************************************************
' estimate ARCH/GARCH model
equation arch1.arch(1, 2) returns c

' save residuals

arch1.makeresid resarch

' save arch variance series

arch1.makegarch vararch

' save standard error of regression

scalar sereg=arch1.@se

'save regression constant

scalar constant = arch1.@coef(1)

' create standardized residuals

genr wgt_resid=resarch/@sqrt(vararch)
genr wgt_resid_sq = wgt_resid^2

' auxiliary regression

equation auxls.ls wgt_resid_sq c wgt_resid_sq(-1 to -12)

' get LM test stat

scalar lm0 = auxls.@r2*auxls.@regobs

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' **********************************************************
' ****** THE MONTE CARLO VALUE OF LM ******
' **********************************************************
matrix(nrep, 1) lm_stat

for !i=1 to nrep

' generate new residuals
genr newu=@rnorm*sereg

' generate new returns

genr returns_hat = constant + newu

' do arch regression

equation arch1_mc.arch(1, 2) returns_hat c

' save residuals

arch1_mc.makeresid resarch_mc

' save arch variance series

arch1_mc.makegarch vararch_mc

' create standardized residuals

genr wgt_resid_mc=resarch_mc/@sqrt(vararch_mc)
genr wgt_resid_sq_mc = wgt_resid_mc^2

' auxiliary regression

equation auxls_mc.ls wgt_resid_sq_mc c wgt_resid_sq_mc(-1 to -12)

' get LM test stat

scalar lm_mc = auxls_mc.@r2*auxls_mc.@regobs
lm_stat(!i,1) = lm_mc

if lm_mc>=lm0 then
scalar count=count+1
endif
next

scalar pvalue=(count+1)/(nrep+1)

wfsave main

Page 20 of 22
A2. Code from bootstrap bias correction

cd "\\home\mcmow\econ546\project\"

wfcreate(wf=bias_correct, page=undated) u 17155

' import data

import GSP.xlsx

' generate variables

genr log_price = log(price)
genr returns = log_price-log_price(-1)
genr returns_sq = returns^2

rndseed 88888888
scalar nrep=100

equation arch1.arch(1, 2) returns c

scalar tb=arch1.@coef(1)
arch1.makeresids res

scalar sum=0

for !i=1 to nrep

res.resample(fixna) *_b
genr returns_b=arch1.@coef(1)+res_b

equation arch2.arch(1, 2) returns_b c

scalar sum=sum+arch2.@coef(1)
next

scalar tbarb=sum/nrep
scalar bias_boot=tbarb-tb
scalar t_boot=2*tb-tbarb

scalar sum2=0

for !i=1 to nrep

res.resample(fixna) *_b
genr returns_b=arch1.@coef(1)+res_b

equation arch2.arch(1, 2) returns_b c

scalar sum2=sum2+(tbarb-arch2.@coef(1))^2
next

scalar vboot=sum2/nrep

wfsave bias_correct

Page 21 of 22
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