Question

In an attempt to “time the market,” a financial analyst studies the quarterly returns of a stock. He uses the model y = β0 + β1d1 + β2d2 + β3d3 +  where y is the quarterly return of a stock, d1 is a dummy variable that equals 1 if quarter 1 and 0 otherwise, d2 is a dummy variable that equals 1 if quarter 2 and 0 otherwise, and d3 is a dummy variable that equals 1 if quarter 3 and 0 otherwise. The following table shows a portion of the regression results.


a. Given that there are four quarters in a year, why doesn’t the analyst include a fourth dummy variable in his model? What is the reference category?
b. At the 5% significance level, are the dummy variables individually significant? Explain. Is the analyst able to obtain higher returns depending on the quarter?
c. Explain how you would reformulate the model to determine if the quarterly return is higher in quarter 2 than in quarter 3, still accounting for allquarters.


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  • CreatedJanuary 28, 2015
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