Financial Econometrics

– This is an individual assignment. It should reflect your individual effort

– The  assignment  should  be  typed,  with  the  main  tables,  charts  and  results  presented

throughout the assignment to highlight your responses to the questions

– There should be no appendices (appendices will not be marked)  

– Marks will be awarded for neatness, conciseness and clarity of answers

– Where answers call for explanation, a simple reporting of numerically correct results

will yield few (if any) marks

– When conducting hypothesis tests, outline all steps in your answer

– Maximum number of pages allowed: 10  (additional

pages will not be marked)

– Pages should be numbered

– Be as concise as you can, while clearly addressing each question

Total marks: 30 

 

 

Submission instructions    

– You are required to submit the assignment in both print and electronic copies

– Electronic submission is via a submission link on

iLearn

– Print  copy  (with  a  signed  assignment  coversheet)  must  be  submitted  at  BESS  (E4B)  –

ensure  you  know  your  tutor’s  name,  as  there  will  be  separate  submission  boxes  for

each tutor

– A  link  to  the  FBE  cover  sheet  is  provided  under  the  “Assignment”  heading  on  iLearn

Fill in

the details of the cover sheet and staple it to the front of your assignment

 

Part 1

Part 1 – Total number of marks: 15

The Eviews workfile “Part1_Assignment_Workfile.wf1” located under “Assignment” heading

on  iLearn  contains  four  series  for  the  period  June  1972  –  February  2016  (525  observations).

The following variables are included:

 

 

  1. Monthly prices for

cvs

(CVS Health which is a U.S. pharmaceutical company)

  1. Returns on three pricing factors from Fama and French (1993)

_mkt rf

Market            Risk     Premium

hml

High    minus  Low

smb

Small   minus  Big

rf

(the U.S. risk free rate)

Answer the following questions based on this dataset:

 

  1. How  are  the  factors  computed  and  what  do  they  represent?  (Hint:  Look  at  the  Fama

and French 1993 paper – its on iLearn). Briefly describe major company characteristics

of CVS Health. (2 marks)

 

  1. Create

log returns (in percent, e.g. 3.25%) and name them  _.r cvs  Calculate the excess

return  on

cvs

stock  as

_r cvs rf

and  name  it  _.er cvs    Consider  the  following

model:

er cvs mkt rf hml smbb bbbe=+ + + +

What signs (positive or negative) would you expect to estimate for each of the factors?

__

Why? (3 marks)

 

01 2 3

ttttt

  1. Estimate  the  model  in  B  and  present  the  fitted  equation.  Interpret  the  fitted

coefficients.  Which  parameters  are  statistically  significant  at  the  5%  level?  Are  the

estimated parameters of the same

sign as you expected in B? (4 marks)

 

  1. Conduct a test for the validity of the CAPM. What do you find? (3 marks)

 

  1. Conduct the basic diagnostic tests on the estimated model, i.e. autocorrelation (use 4

lags  of  residuals),  heteroskedasticity  (no  cross  product),  non-normality,

misspecification  of  functional

form  (only  quadratic  term).  Comment  on  your  results

and  suggest  remedies  to  any  problems  you  may  detect.  (You  are  NOT  required  to

carry out the remedy to any problem you may detect. If you see a problem, state what

it is and simply describe what could be done).  (3 marks)

 

Part 2

Part 2 – Total number of marks: 15

The Eviews workfile “Part2_Assignment_Workfile.wf1” located under “Assignment” heading

on iLearn contains daily adjusted closing price for Qantas from 01 Jan 2007 to 12 April 2016,

which is 2,414 daily observations. It is designated “Qan” in the workfile.

 

  1. Plot a graph of the Qantas

share price, and comment on its salient features. Conduct

an  ADF  unit-root  test  on  the  price  series.  Be  careful  to  properly  state  the  null  and

alternative hypothesis for the test. Comment on your findings.

(2 marks)

 

  1. Generate  a  new  variable  for  the  daily  log  returns  (in  percentage  terms)

for  Qantas.

Name  this  variable

_.r qan

Present  a  graph of  the  return  series  along  with  summary

statistics,  and  comment.  Conduct  a  KPSS  unit-root  test  on  the  returns  for  Qantas.  Be

careful to properly state the null and alternative hypothesis for the test.  Comment on

your findings.

(2 marks)

 

  1. Plot  the  ACF  and  PACF  functions

for  Qantas  returns  (include  5  lags).  On  the  basis  of

these results, you decide to estimate three models for Qantas returns. They are:

rqan b e=+     (1)

_

_

1

tt

r qan b be e

=+ +   (2)

121

ttt

r qan r qanb be

=+ +  (3)

Which model do you think is the best from among these three?

(2 marks)

 

__

12 1

ttt

  1. Re-estimate  the  model  you  selected  in  Part  C  by  adding,  respectively,  an  i)  ARCH(5),
  2. ii)  GARCH(1,1)  and  iii)  GJR(1,1,1)  specification.  What  are  these  models,  and  how  do

they  differ?  Report  the  fitted

equations,  comment  on  the  output,  including  a  careful

interpretation  of  the  parameters  in  the  volatility  equation,  and  compare  across  the

three  specifications.  Provide  graphs  of  the  estimated  conditional  variances  and

comment on them. Overall, which one of the three specifications do you prefer?

(9 marks)

References 

 

Fama, E. F. and

French, K. R. (1993). “Common risk factors in the returns on stocks

and bonds”. Journal of Financial Economics 33(3), 3-56.

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