Analysis of Financial Data Chapter 2: Basic Data Handling

Topics Covered in Chapter

Types of financial data

1.

2. Data sources 3. Graphs

4.

Descriptive statistics.

TYPES OF FINANCIAL DATA

Types of Data:

time series data (Yt for t=1,,T)

e.g. stock price every day for several years

cross-sectional data (Yi for i=1,,N)

e.g. data on the share price of N=100 companies.

panel data (Yit for i=1,..,N and t=1,,T)

e.g. exchange rate for N countries for last T months Y is referred to as a variable (e.g. it varies across companies)

Qualitative & Quantitative Data Quantitative data is numerical e.g. share price is $25 Qualitative data is not e.g. in a survey of companies ask if investment financed through debt (as opposed to equity or retained earnings). Answer is Yes/No. Dummy variable equal 0 or 1. Used for turning qualitative data into quantitative e.g Yes =1, No = 0

Data Transformations: Levels, Growth Rates, Returns and Excess Returns Often original data is transformed e.g. if X = company earnings, and W = number of shares, you can create a new variable: Y = X/W which is earnings per share. When working with asset prices (e.g. price of shares) following transformations are common

Yt is the Level = the original variable (e.g. price of share)

Growth rate is the percentage change

(Yt +1 Yt ) 100 Yt

% change =

Properties of logarithms can be used to show: % change 100 [ln(Yt)-ln(Yt-1)].

 Return on an asset is almost the same as its growth rate. But this ignores dividends.
(Yt Yt 1 + Dt ) 100 . Yt 1

Return =

Rt =

Excess return is important in much financial decision making

Excess return is the return above what a safe, risk free asset would give:
ER t = Rt R0t .

R0t is the return on the safe asset (e.g. a government bond)

Index Numbers Many variables that financial analysts work with come in the form of index numbers.

E.g. The Dow Jones Industrial Average (DJIA) and Standard and Poors composite share index (S&P500) are stock price indices. E.g. Suppose you are interested in studying the performance of the stock market as a whole. An index will measure this. The price of the stock of an individual company (e.g. Microsoft, Ford or Walmart, etc.) can be readily measured. Index measures price of stock market as a whole.

Price index takes the weighted average of share prices of a set of companies (e.g. the biggest 500 companies). weights in weighted average are values of each company (so big companies have more weight than small)

Index Numbers (continued) Indices are usually normalized to that a base year is 100 (or 10,000 or some base)

E.g. suppose an index is Y1=100, Y2=106, Y3=109 and Y4=111. First year has been selected as a base year and, accordingly, Y1=100. Figures for other years are all relative to base year and allow for a simple calculation of how prices have changed since the base year. For instance, Y2=106 means that prices have risen from 100 to 106 a 6% rise since the first year. It can also be seen that prices have risen by 9% from year 1 to year 3 and by 11% from year 1 to year 4. A price index is very good for measuring changes in prices over time, but should not be used to talk about the level of prices. It should not be interpreted as an indicator of whether prices are high or low.

Obtaining Data
Many web sources (often though, they cost money)

University data libraries often have access to DataStream (http://www.datastream.com/) and Wharton Research Data Services (http://wrds.wharton.upenn.edu/). For free sources try the Federal Reserve Bank of St Louis (http://research.stlouisfed.org/fred2/) or the Financial Data Finder provided by the Fisher College of Business at the Ohio State University Many academics also make the data sets they have used available on their websites. For instance, Robert Shiller at Yale University has a good website.

Working with Data: Graphical Methods

Graphs can be used information in a data set.

to

summarize

There are many kinds (experiment with your software package to see what is possible). Here we give a few examples.

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Time Series Graph

Example: Monthly /$ exchange rates from January 1947 to October 1996. See Figure 2.1

Figure 2.1: Time Series Graph of U.K. pound/U.S. dollar Exchange rate
450 400 350 Pence per dollar 300 250 200 150 100 50 0

Jan-53

Jan-47

Jan-49

Jan-51

Jan-55

Jan-57

Jan-59

Jan-61

Jan-63

Jan-65

Jan-67

Jan-69

Jan-71

Jan-73

Jan-75

Jan-77

Jan-79

Jan-81

Jan-83

Jan-85

Jan-87

Jan-89

Jan-91

Jan-93

Date

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Jan-95

Histograms
Example: real GDP per capita in 1992 for 90 countries measured in $US. Questions of interest: What is the distribution of income across countries? What is the extent of global inequality? Related to the idea of a distribution.

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Steps in Construction of Histogram

Note: Software packages can do all these steps automatically. 1. Construct class intervals (or bins). Real GDP per capita in our data set varies from $408 in Chad to $17,945 in the U.S. Class intervals must include these extremes. One choice of class intervals (many choices possible): Bin 1: $0-$2,000 Bin 2: $2,001-$4,000 Bin 3: $4,001-$6,000 Bin 4: $6,001-$8,000 Bin 5: $8,001-$10,000 Bin 6: $10,001-$12,000 Bin 7: $12,001-$14,000 Bin 8: $14,001-$16,000 Bin 9: $16,000 or more

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Steps in Construction of Histogram (cont.)

2. Calculate frequencies. Count the number of countries whose GDP per capita falls in each bin. 3. Make a bar chart with the bins on the x-axis and frequency divided by class width on the yaxis. See Figure 2.2.

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Figure 2.2: Histogram

35 30 25 20 15 10 5 0

Frequency

Frequency

Bin 2000 4000 6000 8000 10000 12000 14000 16000 M ore

Frequency 33 22 7 3 4 2 9 6 4

12000

14000

Bin

16000

10000

More

2000

4000

6000

8000

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Graphical Methods (cont.)

C.XY-plots (scatter diagrams) Example: Executive compensation and profits of 70 companies Question of interest: Do companies with higher profits also pay their executives more? Plot of one variable versus another (e.g. profits on y-axis, executive compensation is on x-axis). Each point on graph represents profits and executive compensation for one company. See Figure 2.3

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3000

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Interpretation of XY-plots
There seems to be a positive relationship between executive compensation and profits Companies with low profits also tend to have low executive compensation (i.e. low-low) Companies with high profits also tend to have executive compensation (i.e high-high) A negative relationship would have low-high and high-low. Outliers: Companies which do not fit the general pattern.

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Descriptive Statistics
Example (continued): real GDP per capita for 90 countries. Remember: histogram summarises crosscountry income distribution. Descriptive statistics are numbers which summarise properties on income distribution.
1.

Measures of location.

Intuition: centre of distribution, average, typical country. Mean

Y i Y= N
Mean/average GDP per capita is $5,443.80 Note:

=
N

i=1

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Descriptive Statistics (cont.)

2.

Measures of dispersion.

Intuition: spread/variability/dispersion of distribution, inequality. Standard deviation:

(Y Y )2 i s= N 1

Variance = standard deviation squared.

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Expected Values and Variances

Above we talked about means and variances. Formally these are sample means and sample variances. Sample emphasizes that they are calculated using an actual sample of data. Population means and population variance are related concepts which we will try and motivate using an example Suppose we have data on the return to holding stock in a company for the past 100 months. We can use this data to calculate the sample mean and variance. However, these numbers are calculated based on the historical performance of the company. What about predicting future stock returns? We do not know exactly what these will be, so cannot calculate sample means and variances as we did above. But a potential investor would be interested in some similar measures.

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Investor would be interested in the typical return which she might expect.

She might also be interested in the risk involved in purchasing the stock.

The concept of a typical expected value sounds similar to the ideas we discussed relating to the mean. The concept of riskiness sounds similar to the idea of a variance. We need concepts like the sample mean and variance, but for cases when we do not actually have data to calculate them. The relevant concepts are the population mean and population variance.

Let Y denote next months return on this stock. From the investors point of view, Y is unknown.

The typical return she might expect is measured by the population mean and is referred to as the expected value. We use the notation E(Y) to denote the expected return.

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 The expected value sheds light on what we expect will occur. However, the return on a stock is rarely exactly what is expected (i.e. rarely will you find Y to turn out to be exactly E(Y)).

Stock markets are unpredictable, there is always risk associated with purchasing a stock. Variance relates to this risk. We use the notation var(Y) for this.

Details about calculate expected values and variances are in the textbook.

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Summary
1. Financial data come in many forms. Common types are time series, cross-sectional and panel data. 2. Financial data can be obtained from many sources. The internet is becoming an increasingly valuable repository for many data sets. 3. Simple graphical techniques, including histograms and XY-plots, are useful ways of summarizing the information in a data set.
4.

Many numerical summaries can be used. The most important are the mean, a measure of the location of a distribution, and the standard deviation (and variance), measures of how spread out or dispersed a distribution is. If Y is a variable which could have many outcomes, then the expected value, E(Y), is a measure of the typical or expected outcome and the variance, var(Y), is a measure of the dispersion of possible outcomes

5.

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