On the Size Control of the Hybrid Test for Predictive Ability

We analyze theoretical properties of the hybrid test for superior predictability. We demonstrate with a simple example that the test may not be pointwise asymptotically of level $\alpha$ at commonly used significance levels and may lead to rejection rates over $11\%$ when the significance level $\alpha$ is $5\%$. Generalizing this observation, we provide a formal result that pointwise asymptotic invalidity of the hybrid test persists in a setting under reasonable conditions. As an easy alternative, we propose a modified hybrid test based on the generalized moment selection method and show that the modified test enjoys pointwise asymptotic validity. Monte Carlo simulations support the theoretical findings.
Comment: 40 pages