A researcher estimates the following model for stock market returns, but thinks that there may be a problem with it. By calculating the t-ratios, and considering their significance and by examining the value of R2 or otherwise, suggest what the problem might be.

ˆyt = 0.638 + 0.402x2t − 0.891x3t R2 = 0.96, ¯R2 = 0.89

(0.436) (0.291) (0.763) (4.75)

How might you go about solving the perceived problem?

AppendixLO1