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Robust Estimation of Regression Models with Potentially Endogenous Outliers via a Modern Optimization Lens

Econometrics 2024-08-08 v1

Abstract

This paper addresses the robust estimation of linear regression models in the presence of potentially endogenous outliers. Through Monte Carlo simulations, we demonstrate that existing L1L_1-regularized estimation methods, including the Huber estimator and the least absolute deviation (LAD) estimator, exhibit significant bias when outliers are endogenous. Motivated by this finding, we investigate L0L_0-regularized estimation methods. We propose systematic heuristic algorithms, notably an iterative hard-thresholding algorithm and a local combinatorial search refinement, to solve the combinatorial optimization problem of the L0L_0-regularized estimation efficiently. Our Monte Carlo simulations yield two key results: (i) The local combinatorial search algorithm substantially improves solution quality compared to the initial projection-based hard-thresholding algorithm while offering greater computational efficiency than directly solving the mixed integer optimization problem. (ii) The L0L_0-regularized estimator demonstrates superior performance in terms of bias reduction, estimation accuracy, and out-of-sample prediction errors compared to L1L_1-regularized alternatives. We illustrate the practical value of our method through an empirical application to stock return forecasting.

Keywords

Cite

@article{arxiv.2408.03930,
  title  = {Robust Estimation of Regression Models with Potentially Endogenous Outliers via a Modern Optimization Lens},
  author = {Zhan Gao and Hyungsik Roger Moon},
  journal= {arXiv preprint arXiv:2408.03930},
  year   = {2024}
}