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Financial Econometric Exercises

The document outlines key concepts in financial econometrics, including definitions of financial econometrics, regression analysis, and the Capital Asset Pricing Model (CAPM). It discusses hypothesis testing in financial contexts, time series properties, and models, as well as long-run relationships in finance such as cointegration and GARCH models. Additionally, it covers model diagnostics, testing methodologies, and the applications of various econometric models in financial decision-making.

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46 views4 pages

Financial Econometric Exercises

The document outlines key concepts in financial econometrics, including definitions of financial econometrics, regression analysis, and the Capital Asset Pricing Model (CAPM). It discusses hypothesis testing in financial contexts, time series properties, and models, as well as long-run relationships in finance such as cointegration and GARCH models. Additionally, it covers model diagnostics, testing methodologies, and the applications of various econometric models in financial decision-making.

Uploaded by

pridetalent96
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Financial Econometrics – ECD402

1. Definition, Concepts and Data


a) What is
i) financial econometrics?
ii) Regression analysis? simple linear and multiple regression models?
b) Specify a simple linear regression model for a CAPM.
i) Define all the terms of the model
ii) Suggest how the model parameters are estimated?
iii) How the parameters are interpreted?
iv) What is the BLUE property? How does an econometrician ensure that the
property is achieved?
c) List different types of financial data and the stylized properties of asset returns.
d) List all violations of the assumptions classical linear regression model and explain
model diagnostic tests.
e) What is model specification?

2. Testing financial hypotheses


a) Given the regression results (N.B. the number in parentheses i.e. in brackets are standard
errors )

=0.85.
i) Using both the test of significance and confidence interval approaches, test the
hypothesis that β = 1 against a two-sided alternative?
ii) Test the significance of each coefficient at 5%. Interpret the R-squared.
b) You estimate a regression of the form given by (3.52) below in order to evaluate the
effect of various firm-specific factors on the returns of a sample of firms. You run a
cross-sectional regression with 200 firms
iii) For the model above, explain how you can test the validity of the whole model?

c) What is
i) the efficient market hypotheses?
ii) Beat-the-market hypothesis?
iii) Pecking order hypothesis?
iv) Modigliani Irrelevant hypothesis?
v) Jensen alpha hypothesis?
d) Explain how these hypotheses can be tested using regression analysis?
e) The analyst also tells you that shares in Chris Mining PLC have no systematic risk, in
other words that the returns on its shares are completely unrelated to movements in the
market. The value of beta and its standard error are calculated to be 0.214 and 0.186,
respectively. The model is estimated over 38 quarterly observations. Write down the
null and alternative hypotheses. Test this null hypothesis against a two-sided
alternative.

f) Suppose that you had estimated CAPM and found that the estimated value of beta for
a stock, βˆ was 1.147. The standard error associated with this coefficient SE(βˆ) is
estimated to be 0.0548. A city analyst has told you that this security closely follows the
market, but that it is no more risky, on average, than the market. This can be tested by
the null hypotheses that the value of beta is one. The model is estimated over 62 daily
observations. Test this hypothesis against a one-sided alternative that the security is
more risky than the market.

3. Time series properties


a) What is strict stationarity? Covariance stationary? Why is it that financial asset prices
or returns should be stationary?
b) Explain the properties of the following models of non-stationarity and sketch the
processes
i) Random walk, random walk with a drift, random walk with drift and trend.
ii) deterministic trend process:
c) how do you test for non-stationarity using
i) ACF
ii) ADF
4. Time Series Models
a) What is univariate modelling?
b) Explain the structure of the following models AND THEIR APPLICATIONS IN
FINANCE
i) Moving average [MA (q)]
ii) Autoregressive [AR(p)]
iii) ARMA(pq)
c) Explain the Box and Jenkins approach l (ARMA modelling). In your explanation
outline how the following plays a significant role in building the model
i) Stationarity property
ii) ACF and PACF
iii) Information criteria
iv) Significant tests and Q-statistics
d) What is forecasting?
i) What is the difference between “In sample and out of sample” forecasting?
ii) How do you forecast using structural models? Time series models- ARMA
and GARCH?
iii) Explain the process of forecast evaluation?
5. Long run relationships in finance
a) Define the following terms
i) Unit root
ii) Integrated series
iii) Cointegrated series
iv) Engle Granger representation theorem
v) Error correction model

b) How do you test for cointegration using the Engle -Granger approach?
ii)State and explain five concrete examples where one would apply
cointegration approach in finance.
c) What motivated the development of GARCH models?
Outline the GARCH model and explain its properties and strengths. How is the model
estimated and used for financial decision making?
iii) State and explain the GARCH Models extensions
d) Compare and contrast different limited dependent model? Explain one example in
finance where the models are appropriate.

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