Finite sample inference in multivariate instrumental regressions with an application to Catastrophe bonds*

Abstract

Abstract We propose exact exogeneity tests and weak-instruments-robust tests on factor loadings for a system of regressions with possibly non-Gaussian disturbances. Our methodology is valid in finite samples and accounts for common cross-sectional factors. Analytical invariance results are derived, with companion simulation studies. Finally, a total-effect parameter is introduced that embeds the unobservable endogeneity factor. Proposed tests are applied to assess whether Catastrophe bond mutual funds co-move with financial markets. Significant risk premiums are detected globally and over time, although they are less pervasive from a domestic currency perspective. Findings underscore the importance of instrumenting and assessing direct and total effects.