Econometrics and financial statistics analysis - Essay Example

ASSIGNMENT Testing for the presence of Unit Root: Viewing the trends of the data and the series, it has been established the data presented has been quite helpful in establishing a viable basis for forecasting purpose. The return data of two companies i.e RETEDIN and RETFTSE ALLSHARE help provide us series. Methodology: In order to smooth the data series data and establish a more meaningful series for forecasting purposes, we should first taken quarterly averages of the data series by taking the average of the three months across each quarter.

Following that and as per the protocols defined by Koop (2003, p 154-156), we can conduct a unit root test for each of the two variables first to establish whether or not the the series have a unit root. In order to test the series for a unit root, we can use use The Dickey-Fuller unit root test which can be applied. In order to do the Dickey-Fuller test on , we can use the following regression: (theorangedog.net) , and test the hypothesis that . If we can’t reject the null hypothesis, we say that the series has a unit root.

In order to do this test in Excel, we computed . Our X variable is ‘’, for t –1 = 1,…,65 (or t = 2,…, n). In other words, we are regressing on lagged values of . Identify an appropriate univariate model for the estimation of each return series. Comment on the procedure adopted and pay particular attention to the identification, estimation and diagnostic stages of the modelling process. We can establish a univariate regression model for estimating the returns on each series. In developing this model, we can use quarterly average data series as Y or dependent variable, and RETEDIN series as X1 or first independent variable and RETFTSE ALLSHARE series as X2 or second independent variable.

We can also calculate the correlation coefficients and coefficients of determination between the Y series with each of the two return series. After reviewing the statistics that validate the model, we can use this model to forecast returns. If these forecast figures show a narrow error margin, it indicates that the model developed is a robust one. Estimate the beta value for your share using a ‘market model’ specification and check the adequacy of the model using appropriate diagnostic tests.

The beta value (β) or the slope of the returns series of the market model can be calculated using the linear regression based on least squares method and the resulting coefficients of the intercepts and slope along with their related t-statistics and p-value will indicate the validity of these estimates. If the p-value of the estimated beta values is less than 0.05, we will conclude that the beta value estimate calculated by our model is valid and adequate for our purpose on hand. Explain what you understand by the term ‘stock market crash’.

In September 2001 there was a significant stock market downturn. Using appropriate econometric techniques, test whether this event caused a significant change in the beta value of your share during the sample period. Comment on your results. According to investopedia.com, a stock market crash refers to a significant drop in the total value of a market in a relatively short span of time and be attributable to a bubble, thus leading to a financial situation wherein all the majority of investors are obliged to try to leave the market at the same time with the result that they have to reduce their stock prices.

The beta value of our share must be negative in timers of economic downturn or stock market crash of 2001. A negative beta value with a p-value of less than 0.05 would indicate that the probability that the estimated beta value is erroneous is less than 5%. Thus the 95% confidence level can be attached to state that the stock market crash affected a trend in returns on the stocks of the two companies or our data series i.e RETEDIN series and RETFTSE ALLSHARE. References: 1. Koop, Gary. (2003) Analysis of economic data, 2nd edition: John Wiley & Sons 2.

Hill, Griffiths, Judge Undergraduate Econometrics 3. “How to do a ‘Regular’ Dickey-Fuller Test Using Excel. Downloaded from: theorangedog.net/wp-content/uploads/./dickey-fuller-example.doc (accessed: 20.05.2011) 4. onlineregression13:   Multiple linear regression http://onlineregression.sdsu.edu/onlineregression13.php Accessed: (20.05.2011) 5. http://www.investopedia.com/features/crashes/crashes1.asp#axzz1tCUFb2Aj