[Solution]Application of financial econometric techniques

Application of financial econometric techniques Weight – 60% Individual Assessment II INSTRUCTIONS The assignment must be word-processed. The whole assignment must be no more than…

Application
of financial econometric techniques

Weight
– 60%

Individual
Assessment II

INSTRUCTIONS

The assignment must be word-processed.The whole assignment must be no more
than 1250 words in length including any,
GRAPHICS BUT NOT REFERENCES. The word count must be stated at the end of the assignment.Your Word file MUST be submitted to Turnitin via Blackboard. The assessment criteria detailed
overleaf will be used to mark your assignment. Please bear the criteria in mind
when preparing your assignment. The assignment is worth 60% of the total
module mark.

MAIN PURPOSE

The purpose of this assignment is to
make students familiar with some contemporary econometric techniques used to
examine finance theories. You are required to make proper use of both financial
theory and empirical practice using EViews.

SCENARIO

You are a Junior Analyst for F& H Investment
with the responsibility of tracking stock in the FTSE-100 index. Your boss
proposes to upgrade the financial risk management methodology the company uses.
Your boss further proposes that, after several successful years of operation in
the UK, the company is now considering expanding its operation to cover other
European countries.

As the
financial analyst, you are required to select any one FTSE-100 stocks from a
relevant database (e.g., Eikon/DataStream, Bloomberg, Yahoo Finance) and
estimate their excess return series.

Use monthly
observations from the last 15 years unless your firm is listed on the stock
market after the start date.

[Hint: Use the selected firm and return series
from Assignment 1]

REQUIREMENTS

Part
1.

For each of the series:

Perform the ADF and KPSS tests of
stationarity in EViews, clearly stating your hypotheses. Comment on your
results in line with relevant financial theory.                              [15
marks]

Estimate the best fitting ARMA/ARIMA
model, following the Box-Jenkins methodology. Assess the adequacy of your
results and formulate appropriate diagnostic procedures. Produce dynamic
“out-of-sample” forecasts for the returns and discuss your findings about
their accuracy.                                                                                                                   [30
marks]

Your boss suggests using ARCH(1) process
to model the returns volatility. You disagree and wish to convince your boss
that a GARC(1,1) process is better. Estimate both models and try to convince
your boss about the preferability of the model you are proposing.                                                                                                                                                [25
marks]

Part
2.

Pair the
FTSE-100 index with any other two (2) country stock indices (posted on
Blackboard) and test for cointegration among the pairs of variables by applying
the Engle-Granger (EG) approach. Critically comment on your results.                                                                                                                                                                                                                                                                      [20
marks]

 A
well laid-out structure and presentation (executive summary, referencing,
layout)       [10 marks]

 

WRITTEN
REPORT

The written report should be 1,250 words
(plus or minus 10%) in length (including, plots and pictures but not the reference
list), word-processed and should be of a professional format suitable for the
audience. You should also attach all relevant tables with summaries of results
as an appendix to your report. In the report you should:

Explain
the rationale behind your empirical tests and the methodology adopted.
This part has to be concise and precise. No marks will be given for
clutter.You must
use the appropriate scientific rhetoric. Therefore, you should define
clearly your null and alternative hypotheses tested in each stage of the
analysis. Provide
a clear definition of the techniques/econometric tests used and WHY they
are used.Be
precise in the underlying theory and relate this to your results and
discussion.

ASSESSMENT
AND MARKING SCHEME

The majority of the marks will be given
to students that produce evidence of:

Good
understanding of the underlying theory and concepts.Good
understanding of econometric analysis.Ability
to link properly the first two points aboveCritical
thinking in the interpretation of the findings.

The
grade you achieve for this part will depend entirely on the level of
understanding demonstrated in your report and your sound empirical backing.

In terms of referencing, you are required to use the
Harvard system of citation. Also, beware of the academic regulations regarding plagiarism.

HINTS

I
strongly recommend that you get a copy of the EViews manuals as soon as possible
to familiarise yourself with elementary statistics and hypothesis testing
procedures. Use your lecture notes and relevant sources to grasp the theory
behind efficient markets and basic financial econometrics.

Think
about potential problems of financial time series such as those of heteroscedasticity,
autocorrelation and non-stationarity. You should correct and comment on
any possibility of these errors affecting your analysis.

ADDITIONAL
SUGGESTED READINGS

Brooks, C. (2008). Introductory
Econometrics for Finance, 2nd
Edition (2011). Cambridge University Press.

Asterious, D., & Hall, S. G. (2015).
Applied econometrics. Macmillan International Higher Education.

Gujarati, D. (1995). Basic
Econometrics. 3rd Edition. McGraw-Hill.

Maddala, G.S. (2001). Introduction to
Econometrics. 3rd Edition. John Wiley & Sons.

Literature
review:

Barari,
M. (2004). Equity market integration in Latin America: A time-varying
integration score analysis. International Review of Financial Analysis, 13(5),
649-668.

Caporale, G. M., &
Pittis, N. (1998). Cointegration and predictability of asset prices1. Journal
of International Money and Finance, 17(3), 441-453.

Demian,
C. V. (2011). Cointegration in Central and East European markets in light of EU
accession. Journal of International Financial Markets, Institutions and
Money, 21(1), 144-155.

Fama, E. F. (1991).
Efficient capital markets: II. The journal of finance, 46(5),
1575-1617.

Granger,
C. J. (1986). Developments in the study of cointegrated economic variables. Oxford
Bulletin of economics and statistics, 48(3), 213-228.

Gregory, A. W. and Hansen, B. E. (1996).
“Residual-Based Tests for Cointegration in Models with Regime
Shifts”, Journal of Econometrics, Vol. 70, pp. 99-126.

Johansen,
S. (1988). Statistical analysis of cointegration vectors. Journal of
economic dynamics and control, 12(2-3), 231-254.
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