Model Specification Errors
Let’s say you are modeling a bank’s (just one bank in the industry) customer deposits using a multivariate regression (over a period of time). One of the independent variables you are considering is money supply (M3). A component of Money supply (M3) is bank deposits (for the industry). Would the model be correctly specified if you include money supply as a variable? My confusion is coming from the fact that the M3 forecast is an industy forecast and will implicitly include the bank’s deposits. Howver, determining beta of a stock using regression also has a simialr thing (market returns will include returns on the stock). I’m trying to avoid “forecasting the past” error.
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