ECONOMETRICS

PART 1
ECONOMICS AND FINANCE
M-EF_6
SUMMER TERM 2015

1. INTRODUCTION
STRUCTURE

1.1 What is Econometrics?

1.2 Financial vs. Economic Econometrics
1.3 Types of Data

1.4 Formulating an Econometric Model

1.5 Articles in Empirical Finance
1.6 Econometric Software Packages
1.7 Learning Outcome

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1. INTRODUCTION
PRELIMINARY REMARKS
Econometrics on an introductory level
(no prior knowledge of econometrics required)
but sophisticated background in maths and (inferential) stats
Some theory, but
emphasis will be on using and applying techniques
(case studies from literature, exercises)
Examples and terminology predominantly from finance
(and partly from economics)
Finance compared to pure economics has gained importance
Consult additional finance literature (CAPM, APT, etc.)
Repeat maths and stats if relevant

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1.INTRODUCTION
1.1 WHAT IS ECONOMETRICS?
Meaning: measurement in economics
Not only applied in economics, main techniques are of equal
importance in finance; here: financial econometrics
application of statistical methods to problems in finance
Examples
Testing theories in finance (e.g. CAPM, APT, Black-Scholes, etc.)
Determining asset (often stock) prices/returns
Testing hypotheses concerning relationships of variables (spot and
future markets, information efficiency, exchange rates, volatility)
Effects of changes in economic conditions or of announcements on
financial markets; forecasting values (level and volatility of returns)
Decision-making (trading rules, hedging)

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1. INTRODUCTION
1.2 FINANCIAL VS. ECONOMIC ECONOMETRICS

Toolkit same
but problems (or emphasis) and data sets different

Data: differences in frequency, accuracy, seasonality,

Economics
Often lack of data

Sometimes measured or estimated with error

Subject to many revisions

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1. INTRODUCTION
1.2 FINANCIAL VS. ECONOMIC ECONOMETRICS

Normally not the case in finance (one problem: stock market

index rebalancing or rebasing)
Available: different types of financial data, long history, many
sources, higher frequency
In finance problems with handling and processing a large
amount of data real trend/pattern or random features?

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1. INTRODUCTION
1.3 TYPES OF DATA
Time series data
Collected over a long period of time on one/more variable(s)
of one object
Particular frequency of observation or collection of data points
(depends on collection/recording): continuously, per minute/hour/day,
weekly, monthly, quarterly, annually,
All data must be of same frequency of observation
Data can be quantitative (prices, quantities shares) or qualitative
(day, rating, characteristics of persons/products)
Examples: stock index vs. business cycle; companys stock price vs.
dividends; trade deficit vs. exchange rate
Data: different variables x1, , xN for many periods t = 1, , T

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FACULTY OF SOCIETY & ECONOMICS

1. INTRODUCTION
1.3 TYPES OF DATA
Cross-sectional data
Data on one/more variable/s collected at a single point in time
(for one day, month, year, )
For different objects (countries, companies, persons, products/services)
Examples: stock prices, returns, ratings of companies; GDP and inflation
of countries
Data: different variables x1, , xN for j = 1, , M objects at t = t*

Panel data
Have both dimensions (time series = over period of time +
cross-sections = for different countries/firms/individuals)
Example: daily prices of stocks of all index companies over three years
Data: different variables x1, , xN for some points in time and objects

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1. INTRODUCTION
1.3 TYPES OF DATA
Continuous vs. discrete data
Continuous data: can take any value (but values can be limited by
precision), determined by measurement; example: return, price, weight
Discrete data: can only take certain values (integers/whole numbers),
determined by counting; examples: persons, companies, shares

Cardinal vs. ordinal vs. nominal data

Cardinal: numerical value has meaning, equal distance between
numerical values (prices, returns, temperature)
Ordinal: provide a position or ordering (position in sports, mark)
Nominal: value without meaning, no ordering, values are arbitrarily
assigned to show a difference (coding assigned to qualitative data, such
as male/female, places/countries, )
Different treatment and modelling

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1. INTRODUCTION
1.4 FORMULATING AN ECONOMETRIC MODEL
1. Statement of problem/s and objective/s
Based on formulation of a theoretical model
Or intuition from financial theory (relation of some variables)
Should be good approximation of reality, useful for purpose

2. Collection of relevant data

Primary data (survey, questionnaire)
Secondary data (information provider, internet, official publications)

3. Choice of estimation method

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Univariate or multivariate approach, single or multiple approach

Functional form of equation

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1. INTRODUCTION
1.4 FORMULATING AN ECONOMETRIC MODEL

4. Statistical evaluation

Assumptions required to estimate model parameters

Assumptions satisfied by data and model?
Does model describe data adequately?
Yes 5.; No 1.-3. again (new model, data, estimation techniques)

5. Interpretation of model
Estimation of sizes/signs fit to theory/intuition
Yes 6.; No 1.-3. again

6. Use of model

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Test the theory, forecasts, suggest action,

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1. INTRODUCTION
1.5 ARTICLES IN EMPIRICAL FINANCE
Clear and specific application of techniques and development
of theory
Published in widely available, peer-reviewed journals
Methodology: techniques validly applied?, tests conducted for
violations of assumptions?
Interpretation of results?, Assessment of strength of results?
Are results related to questions? Replication by other
researchers possible?
Appropriate conclusions (given the results)? Overstatement of
importance of results?

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1. INTRODUCTION
1.6 ECONOMETRIC SOFTWARE PACKAGES
Many available: EVIEWS, GAUSS, LIMDEP, MATLAB,
R (optional tutorial!), RATS, SAS, SPLUS, SPSS (optional
tutorial!), TSP,
Decision about software depends on many criteria

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Compatible with types of data

Suitable for models, familiar with dynamic problems
User-friendly and fast
Inexpensive
Applied in journals/text books
Provide manuals, offer technical support, etc.

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1. INTRODUCTION
1.7 LEARNING OUTCOME

Meaning of time series, cross-sectional and panel data

Difference between qualitative and quantitative, and

continuous and discrete data
Definition of cardinal, ordinal and nominal data

Different steps of formulating an econometric model

(in-depth understanding)

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