Do We Reject Too Often? Small Sample Properties of Tests of Rational Expectations Models

We examine the small sample properties of tests of rational expectations models. We show using Monte Carlo experiments that the asymptotic distribution of test statistics can be extremely misleading when the tine series examined are highly autoregressive. In particular, a practitioner relying on the asymptotic distribution will reject true models too frequently. We also show that this problem is especially severe with detrended data. We present correct small sample critical values for our canonical problem.