ECON334: Financial Econometrics

ASSIGNMENT - S1, 2013

Due date and time: 4pm on Friday of Week 11 (24/05/13)


Instructions
- The assignment should be typed with the main tables, charts and results presented
throughout the assignment to highlight your responses to the questions
- Marks will be awarded for neatness, conciseness and clarity of answers
- Maximum number of pages allowed: 15
- Marks will be deducted for assignments that are badly presented or if the number of
pages exceeds 15.
- There should be no appendices (appendices will not be graded)
- Be as concise as you can, while clearly addressing each question.


Submission instructions
You are required to submit the assignment in both print and electronic copies.
- Electronic submission is via assignment dropbox on iLearn
- Print copy with a signed assignment cover sheet will be due in BESS (E4A)
- 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 A:

The Eviews workfile ford_monthly.wf1 located under Assignment heading on iLearn
contains monthly returns for the period January 1980 November 2011 for the following
series:

1. Monthly excess stock returns for the car company Ford (erford).
2. Four factors based on the Fama-French model and extensions:
a. (Market Return Risk Free Rate),
b. (return on small market capitalization minus big market cap firms)
c. (return on high book-to-market ratio minus low)
d. (momentum, i.e. the average of the returns on two (big and small) high
prior return portfolios minus the average of the returns on two low prior
return portfolios.
3. Four alternative factors based on the Chan, Roll and Ross (CRR) model:
a. (change in US industrial production)
b. (change in US personal consumption)
c. (Risk spread i.e. BAA AAA bond yield)
d. (Term spread i.e. 20yr 1yr bond yield)

Question 1: (10 marks in total)
a. Write one paragraph about the corporation Ford, including the sector it operates in
and a brief summary of its financial profile. (3 marks)
b. Plot the monthly excess returns for Ford and describe the main characteristics
observable in the data. (3 marks)
c. Present summary statistics for the returns, such as mean, variance, skewness,
kurtosis, normality test, and other descriptive statistics you may find interesting.
Comment on your findings. (4 marks)

Question 2: (20 marks in total)
a. Estimate the following model based on the CRR model for Ford:

=
0
+
1

+
2

+
3

+
4

+
5

Interpret and discuss your results. Conduct a test for the validity of the CAPM. What
do you find?
(5 marks)

b. Conduct the basic diagnostic tests on the estimated model, i.e. autocorrelation,
heteroskedasticity, non-normality, misspecification of functional form. Comment on
your results and suggest remedies for problems you encounter (you do not need to
carry these remedies out). (4 marks)

c. Estimate an alternative model based on the Fama-French factors:

=
0
+
1

+
2

+
3

+
4

Interpret and discuss your results. Conduct a test for the validity of the CAPM. What
do you find? (5 marks)

d. Conduct the basic diagnostic tests on the estimated model, i.e. autocorrelation,
heteroskedasticity, non-normality, misspecification of functional form. Comment on
your findings. (2 marks)

e. Which model do you prefer CRR or Fama-French and why? (4 marks)

Part B:
The Eviews workfile ford_daily.wf1 located under Assignment heading on iLearn
contains daily share prices for Ford from 3/1/2011 to 4/4/2013.

Question 1: (20 marks in total)
a. Plot and discuss a graph of the share price.
(1 marks)

b. Conduct ADF and KPSS unit-root tests on the price series. Be careful to properly state
the null and alternative hypotheses for the two tests. Comment on your findings.
(2 marks)

c. Generate a new variable for the daily continuously compounded returns of Ford.
Present summary statistics and comment.
(1 marks)

d. Conduct ADF and KPSS unit-root tests on the returns. Be careful to properly state the
null and alternative hypotheses for the two tests. Comment on your findings.
(2 marks)

e. Choose an optimal (, ) model for the returns based on the AIC criteria up to
a maximum of (4,4) order. You may use the automatic procedure or you may
undertake this manually. Present a table highlighting the minimised AIC value.
(4 marks)

f. Estimate the model selected by the AIC criteria. Interpret the output and
comment.
(2 marks)

g. Conduct the basic diagnostic tests on the estimated model, i.e. autocorrelation,
heteroskedasticity, non-normality, misspecification of functional form. Comment on
your findings.
(2 marks)

h. Re-estimate the model from (e) by adding a (1,1) specification. Comment on
the output. Provide a graph of the estimated conditional standard deviation and
comment on it.
(6 marks)