Financial econometrics

Regression report
Ordinary least square method

Submitted To: Submitted by:

Pro. Amrendra pandey RAHUL LALJIBHAI PANCHOLI (19IB337)
1. INTRODUCTION TO OLS METHOD
For linear models, Ordinary Least Squares (OLS) is the most popular estimation method— and
this is valid for a good reason. So long so your model follows the linear regression OLS criteria,
you can rest easy in the knowledge that you get the best estimates possible.
Regression is a dynamic technique that can simultaneously evaluate multiple variables to address
complex research questions. If you don't fulfill the OLS expectations, however, you may not be
able to trust the findings.
1. The projections are expected to be right on target. We should not be too high or too low
in a systemic context. That is to say, on average they should be impartial or right.
2. Recognizing that forecasts are almost never reliable, you want the difference between
estimated value and actual value to be reduced.
There are 7 assumptions for OLS method
• The regression model is linear in the coefficients and the error term

• The error term has a population mean of zero

• All independent variables are uncorrelated with the error term

• Observations of the error term are uncorrelated with each other

• The error term has a constant variance (no heteroscedasticity)

• No independent variable is a perfect linear function of other explanatory variables

• The error term is normally distributed (optional)

1.1 VARIABLES USED

Tata Consultancy Services Limited (TCS) is a subsidiary of the Tata Group, an

Indian information technology consulting and business solutions. We are researching about is
there any relation exist between NIFTY 50 and NASDAQ which are taken as independent
variable with TCS stock price movements being as dependent variable.
2. LITERATURE REVIEW
Equity market interlinkages showing The nature of the international transmission of stock
returns and volatility has been focus of extensive studies. Earlier studies (e.g., Ripley 1973,
Lessard 1976, and Hilliard 1979, among many others) generally find low correlations between
national stock markets, supporting the benefits of international diversification. The links
between national markets have been of heightened interest in the wake of the October 1987
international market crash that saw large, correlated price movements across most stock
markets: Eun & Shim (1989), Von Furstenberg and Jeon (1989); King and Wadhwani (1990);
Schwert (1990); King et.al. (1994); Longin & Solnik (1995), to name a few.
An Empirical Investigation of Causality and Dynamic Linkages: A Case of Indian and
American Equity In research showing below detect the causal relationship and dynamic
linkages between the NASDAQ Composite Index in US and the NSE Nifty in India during the
period of 1999 to 2004 using intra-daily data. The study carries out a comprehensive analysis
using Granger causality, cross correlation and the application of ARCH and VAR to examine
the co- movement and volatility transmission between Indian and US markets.
Return, Volatility, and Volume : Causality Relationship of Top 10 Companies of Nifty 50
shows the short-run causal relationship between stock returns, stock price volatility, and
trading volume of top 10 companies of the National Stock Exchange. Granger causality test
was applied to the data taken on a quarterly basis from 2008-09 to 2014-15. The study found
bi-directional relationship between stock returns and trading volume of HDFC Bank and TCS,
that is, trading volume was found to reinforce stock returns and returns to reinforce trading
volume. Again, in case of Reliance Industries, bi-directional or two way causal relationships
were found between stock return and volatility. There was uni-directional or one way causality
relationship in case of stock returns and trading volume of Infosys and Reliance, which means
returns Granger cause trading volume, but this does not apply the other way around. This
implies that there is an indication of noise trading model of interaction between stock returns
and trading volume in these stocks.
3. ANALYSIS

Research question
Using linear programming in R we will be trying to find out the relationship between the three
variables- NASDAQ, NIFTY 50 & TCS stock. NASDAQ & NIFTY 50 being the independent
variables and TCS. stock being the dependent variable.
Regression Model
Y = β0 + β1X + β2X’ + u
Where, β0 ⇒ intercept β1⇒ slope β2⇒ slope u ⇒ disturbance or error term, X ⇒ NASDAQ,
X’ ⇒ NIFTY 50 & Y ⇒ TCS. stock
The regression function of our linear model will be:
X<-lm(TCS~NASDAQ+NIFTY 50, data=a)
Hypothesis
H0: There exists no significant relationship between the three variables (NASDAQ, NIFTY
50, TCS. Stock)
H1: There exists significant relationship between the three variables (NASDAQ, NIFTY 50,
TCS. Stock)
Data
Data is of monthly and data taken are for about 3 year that is 2017 to 2020 for all TCS,
NASDAQ, and NIFTY 50 index.
Results
1. Summary of Linear Model
H0: p > 0.05 (Model is not significant)
H1: p < 0.05 (model is significant)
#Where X1 : Nifty 50
X2: Nasdaq
Y : Tcs

2. Our P value is <1.271e-11 which means alternate hypothesis is accepted, implying that our
model is significant
3. The R square of the model is 0.7915 which means that model is better by 79.15% than the
unconditional mean
4. F statistic tells how well the model is explaining than the error, higher F score is better.
5. F= Mean square Model/ Mean Square Error
6. The p-value of the model is 1.271e-11 which is less than 0.05, this means that the overall
model is significant
7. The t value for NIFTY 50 is 0.01 which is less than 0.05 which means that there is
significant relationship but for Nasdaq the t vale is 0.79 which is greater than 0.05 which
means than the relationship with TCS stock is not significant
8. This is a clear problem of multi-collinearity
9. The intercept value for NIFTY 50 is 2.652e-01 which means that with a one unit increase
in NIFTY 50, TCS will increase by 2.652e-01 & id NASDAQ moves by one unit, TCS
moves by 1.839e-01

10. Jarque Bera Test

The Jarque–Bera test is a goodness-of-fit test of whether sample data have
the skewness and kurtosis matching a normal distribution. The test is named after Carlos
Jarque and Anil K. Bera. The test statistic is always non-negative. If it is far from zero, it
signals the data do not have a normal distribution.
 As we know that it is essential to check whether the error terms are normally
distributed(random) ore not. Because if not then it may mean that the prediction is biased, and
also it is an assumption of OLS method.
H0: p > 0.05 (error terms are normally distributed)
H1: p < 0.05 (error terms are not normally distributed)

So, From the results of running jarque bera test on the data, we get the p value= 0.4906 which is
greater than 0.05. This means we accept the null hypothesis, which implies that yes, the error terms
are following normal distribution.

11. Breusch-Pagan Test

The Breusch–Pagan test, developed in 1979 by Trevor Breusch and Adrian Pagan, is used to test
for heteroscedasticity in a linear regression model. It tests whether the variance of the errors from
a regression is dependent on the values of the independent variables. In that case,
heteroskedasticity is present. This is also an assumption of OLS method
H0: p > 0.05 (model is homoscedastic)
H1: p < 0.05 (model is heteroscedastic)

After running the test on the data, we got the p value = 0.047, which is very near to 0.05. So, we
accept the null hypothesis i.e. model is homoscedastic

12. Breusch–Godfrey Test

The Breusch–Godfrey serial correlation LM test is a test for autocorrelation in the errors in a
regression model. It makes use of the residuals from the model being considered in a regression
analysis, and a test statistic is derived from these.
H0: p > 0.05 (error terms are not auto-corelated)
H1: p < 0.05 (error terms are auto-corelated)

After running the test, we see the p value = 5.943e-06 which is substantially less than 0.05, so we
can not dismiss the null hypothesis here thus alternate hypothesis is accepted and error terms are
corelated
13. GGPLOT
With the help of GGPLOT function we can easily plot the linear model as see it visually in the
form a scatter plot and line graph
4. CONCLUSION

We see that NIFTY 50 has a significant relationship with TCS after running the regression
using OLS tool, but NASDAQ does not show a significant relationship. This is a clear case of
multi-collinearity, but the overall pattern is important. After that we test the normality of the
terms of error, in this case our terms of error turned out to be normally distributed, meaning
there is no bias. Since we test weather the variance of error terms depends on independent
variables, our data proved homoscedastic in the test which means that variance of error is not
dependent on independent variables. Lastly, we test the auto correlation in errors, it may lead
to sub-optimal parameter estimation, our data turned out to be auto-correlated, which means
that there may be issues with accuracy and bias. But in the end, we can conclude that the overall
model is significant and we can accept the Alternative hypothesis, i.e. a significant relationship
exists between NASDAQ, NIFTY 50 & TCS stock.
5. REFERENCES

1. https://en.wikipedia.org/wiki/Jarque%E2%80%93Bera_test
2. https://www.wu.ac.at/fileadmin/wu/d/i/ifr/Basic_Financial_Econometrics.pdf
3. Equity market interlinkages
4. An Empirical Investigation of Causality and Dynamic Linkages
5. Return, Volatility, and Volume : Causality Relationship of Top 10 Companies of Nifty 50
6. The role of Breusch test in econometrics.
7. https://en.wikipedia.org/wiki/Breusch%E2%80%93Godfrey_test