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Financial Econometrics Assignment
In finance, it is customary to explain the changes in the extra return on an asset as a linear function of the extra returns on the market portfolio, i.e. 𝑅𝑡 = 𝛼 + 𝛽 × 𝑅𝑀𝑡 + 𝑢𝑡 (1) Where 𝑅𝑡 is the excess return on a stock (with respect to the risk free rate), 𝑅𝑀𝑡 is the excess return on a market index (with respect to the risk free rate).
The main aim of this exercise is to learn regression techniques by applying them to the estimation of equation
(1) in the presence of (possible) anomalies in the stock market. You will analyze the monthly data for M&T Bank for the period July 1996-August 2017. On Moodle, you will find the .txt file with the excess return on the market portfolio, the HML portfolio, the SML portfolio and the risk free rate.
You will also find the Excel file with the stock price of M&T Bank. Introduction The project report should be no longer than 10 pages (font: 11); graphs and tables are more than welcome, and reporting the actual estimation and testing output is encouraged. The submission deadline is the 5th of December, 2017 at 4:00pm. Submissions should be done electronically on Moodle. Assignment
(a) Use the appropriate diagrams and summary tables to discuss briefly the behavior of the excess returns on M&T Bank and the market index.
(b) Estimate the model described in equation (1).
(c) Use your empirical findings in part (b) to test the two null hypotheses: (i) 𝛼 = 0 and 𝛽 = 1 and (ii) 𝛽 = 0.47 = beta of the “regional banks” industry. Interpret your findings using the intuitions linked to the CAPM.
(d) Use your findings in part (b) to test the stability of the estimated parameters of equation (1) (investigate two sub-samples: August 1996-September 2008 and October 1996-August 2017). Interpret your findings.
(e) Modify equation (1) to test for calendar effects (e.g. January effect) and interpret your findings.
(f) Augment equation (1) with the size (SMB) and book‐to‐market (HML) factors to estimate the Fama‐French model. Comment on your results.
(g) Provide an overall assessment of your findings in parts from (b) to (f) regarding the most suitable model to explain the returns of your chosen company.
Discuss, in particular, the goodness of fit.