MASTERS OF SCIENCE IN FINANCE & INVESTMENT

MASTERS IN FISCAL STUDIES

APPLIED FINANCIAL ECONOMETRICS AND DATA ANALYSIS

[CFI 5215]
&
FINANCIAL ECONOMETRICS AND DATA ANALYSIS
[CFS 5201]

(2024)

LECTURER – Z. CHIKAZA
 Introduction
 The application of mathematical statistics to
establish relationships among economic variables,
where an economic variable is one that measures
some aspect of the economy.
 The quantitative analysis of actual economic
phenomena based on concurrent development of
theory and observation, related by appropriate
methods of inference.
 Econometrics is used for:
– Estimating Economic Relationships
– Testing Economic Theories
– Evaluating & Implementing Policy
 What Econometrics Addresses
 There are three basic types of econometric
questions namely:
 Descriptive Questions - Descriptive statistics is
analysis of data that helps describe, show or
summarize data in a meaningful way such that
patterns might emerge from the data.
 How much do men and women earn annually on
average in the Zimbabwe?
 Forecasting Questions - is the process of
making predictions for the future.
 Which Political Party will wins elections in
Zimbabwe in the next 10 years?
 What is the expected growth of GDP for SSA
countries in the next 2 years?
 Highly visible applications of forecasts are
macroeconomic indicators (interest rates,
inflation, GDP etc.)
 Causal Questions - Causation or causality is the
capacity of one variable to influence another.
 If the federal reserve lowers interest rates
today, what will happen to inflation
tomorrow?
 How much more money will you earn as a
result of taking this course?
 The presence of a causal link is suggested by
economic theory (or common sense), the goal
of econometric analysis is either to empirically
verify or quantify this causal link.
 The Nature and Sources
of Data for Econometric
Analysis

1) Types of Data :
• Time series data;
• Cross-sectional data;
• Pooled data
2) The Sources of Data
3) The Accuracy of Data
6
 Types of Economic Data

 All empirical analysis requires data. There are

different structures of data that you come
across if you do empirical analysis in economics:
 The special features of the data sets must be
accounted for or should be exploited to make
correct predictions.
 Cross-sectional data
 Time series data
 Panel (or longitudinal) data
 Cross-Sectional Data

 A cross-sectional dataset consists of a sample of

individuals, households, firms, … taken at a given
point in time
 Cross-sectional datasets are often obtained from
random sampling from the underlying
population.
 Cross-sectional data are usually collected from
respondents making up the sample within a
relatively short time frame (field period).
 In a cross-sectional study, time is assumed to have
random effect that produces only variance, not
bias.
Example 1
Example 2
 Time Series Data
 A time series data set consists of observations on
one or several variables over time.
 Unlike the arrangement of cross-sectional data, the
chronological ordering of observations in a time
series is important.
 A key feature of time series data that makes them
more difficult to analyze than cross-sectional data is
that observations are unlikely to be independent
over time.
 One can quote numerous examples: monthly
unemployment, weekly measures of money supply,
daily closing prices of stock indices, and so on.
 The interval between observations can be any
time interval (hours within days, days, weeks,
months, years, etc).
Example
Some examples of time series are:

 Monthly closings of the stock exchange index

 Malaria incidence or deaths over calendar years
 Daily maximum temperatures
 Hourly records of babies born at a maternity
hospital
 Panel Data / Longitudinal Data
 Panel Data is data in which we
observe repeated cross-sections of the
same individuals.
 Fortunately all of the standard techniques and analysis in
econometrics are equally valid for time series and cross
sectional data
 Have dimensions of both time series and cross sections
 Examples:
 Annual unemployment rates of each state over several years
 Quarterly sales of individual stores over
several quarters
 Wages for the same worker, working at several different jobs
Example
 The key feature of panel data is that we
observe the same individual in more than one
condition.
 In pure panel data, we are following the same
units i.e. the same households or individuals
over time.
Steps in Empirical Model Building
 There is need to come up with an appropriate
economic analysis to have reliable results.
 1. Formulate the Question of Interest.
 The first important step in conducting any
regression analysis is to specify the problem
and the objectives to be addressed by the
regression analysis.
 The wrong formulation or the wrong
understanding of the problem will give the
wrong statistical inferences.
 The choice of variables depends upon the
objectives of study and understanding of the
problem.
2. Choice of Relevant Variables
 It has to be kept in mind that the correct
choice of variables will determine the
statistical inferences correctly.
 For example, in any agricultural experiment,
the yield depends on explanatory variables
like quantity of fertilizer, rainfall, irrigation,
temperature etc.
 These variables are denoted by 1 2 , ,..., XX Xk
as a set of k explanatory variables.
 Step 3: Collection of data on relevant variables

 One important aspect is to collect data on such

relevant variables.
 The data is essentially the measurement on
these variables.
 It is also important to decide whether the data
has to be collected on variables as quantitative
variables or qualitative variables.
 Step 4: Find a suitable economic Form
 The experimenter or the person working in the subject
usually help in determining the form of the model.
 If a model contains only one explanatory variable,
then it is called as simple linear regression model.
 When there are more than one independent variables,
then it is called as multiple regression model.
 When there are more than one study variables, the
regression is termed as multivariate regression.
 The simple and multiple regression are determined by
the number of explanatory variables whereas
univariate and multivariate regressions are
determined by the number of study variables.
Step 5: Choice of method for fitting the data
 After the model has been defined and the data have
been collected, the next task is to estimate the
parameters of the model based on the collected data.
 This is also referred to as parameter estimation or
model fitting.
 The most commonly used method of estimation is
the ordinary least squares method (OLS)
 Under certain assumptions, the least squares method
produces estimators with desirable properties.
 The other estimation methods are the maximum
likelihood method, ridge method, principal
components method
 Step 6: Model Estimation
 The estimation of unknown parameters using
appropriate method provides the values of the
parameter.
 Substituting these values in the equation gives
us a usable model and this is termed as model
fitting .
 The fitted equation is used for prediction.
 Step 7: Model criticism and selection
 The validity of statistical method to be used for
regression analysis depends on various
assumptions.
 These assumptions become essentially the
assumptions for the model and the data.
 The quality of statistical inferences heavily
depends on whether these assumptions are
satisfied or not
 The validation of the assumptions must be
made before drawing any statistical
conclusions.
 EMPIRICAL ECONOMIC ANALYSIS
 They come into play either when we have an economic
theory to test or when we have a relationship in mind that
has some importance for business decisions or policy
analysis.
 Econometrics should always be linked to economic reasoning
 An empirical analysis uses data to test a theory or to
estimate a relationship
 A common goal for applied economists is to estimate the
causal effect of one variable on some outcome of interest.
 Ceteris paribus: other relevant factors being equal, what is
the effect of…
 Price increase on consumer demand
 Training on worker productivity
 In economic thinking, causal relations are
strongly connected with the
notion of ceteris paribus (other things being
equal)
 example: consumer demand analysis –
increasing a price makes consumers buy less
ceteris paribus (however, if other factors change,
anything can happen)
 Therefore, if one could run an experiment with
ceteris paribus conditions enforced, it would be
easy to verify and evaluate the causal link.
 Economic Model of Crime - Example
 Econometric model to specify the crime rate

1. crime is the frequency of criminal activity,

2. wagem is the wage that can be earned in legal
employment,
3. othinc is the income from other sources (assets, inheritance)
4. freqarr is the frequency of arrests for prior infractions (to
approximate the probability of arrest)
5. freqconv is the frequency of conviction
6. avgsen is the average sentence length after conviction.
 The term u contains unobserved factors, such
as the wage for criminal activity, moral
character, family background and errors in
measuring things like criminal activity and the
probability of arrest.
 Points to consider when using models
 Does the work involve testing or developing theory or it is
merely a technique to motivate certain issues.
 Are data of good quality and is it from a reliable source and
is the size of the sample large enough for the model
estimation task at hand.
 Have the techniques been validly applied. Have tests been
conducted for possible violations of any assumptions made
in the estimation of the model.
 Have the results been interpreted sensibly. Is the strength
of the results exaggerated . Do the results actually obtained
relate to the questions posed by the author.
 Can the results be replicated by other researchers.
 Are the conclusions drawn appropriate given results have
been overstated.
 Is Econometrics Necessary?
 Despite inherent inaccuracies in trying to use the
regression analysis, econometrics drives policy setting
and planning
 Econometrics is necessary to move forward in
today’s ever-changing and highly interactive business
environment.
 It enables policy makers to formulate a skilful mix of
quantitative methods which enable sound judgement
for the benefit of our economies.
 In most organizations, we find financial experts who
through ignorance and fear of quantitative
techniques and computers relies solely on qualitative
and fail to formulate good policies.
 Econometrician may acquire skills in
sophisticated data manipulation skills but
unwilling to relate that to the needs of the
organization.
 Analysis, judgement, common sense and
business experience should be combined to
generate good decisions for the firms.
 Macroeconomic Considerations
 There is also a growing interest for predicting
or forecasting important variables for the
entire economy.
 Economic policy is based on projections of
important economic indicators.
 It is very necessary to improve forecasting
techniques to improve economic
performance especially for African Economies.
 TYPES OF FINANCIAL ECONOMETRICS
 Econometrics may be divided into two broad
categories: theoretical econometrics and
applied econometrics.
 Theoretical econometrics is concerned with
the development of appropriate methods for
measuring economic relationships specified by
econometric models. In this aspect,
econometrics leans heavily on mathematical
statistics.
 In applied econometrics we use the tools of
theoretical econometrics to study some
special field(s) of economics and finance, such
as the production function, investment
function, demand and supply functions,
portfolio theory etc.
 Applied econometric methods will be used for
estimation of important quantities, analysis of
economic outcomes, markets or individual
behaviour, testing theories and for forecasting.
END