9. (a) Explain the term parameter structural stability?

(b) A financial econometrician thinks that the stock market crash of October 1987 fundamentally changed the riskreturn relationship given by the CAPM equation. He decides to test this hypothesis using a Chow test. The model is estimated using monthly data from January 1980December 1995, and then two separate regressions are run for the sub-periods corresponding to data before and after the crash. The model is rt = + Rmt + ut so that the excess return on a security at time t is regressed upon the excess return on a proxy for the market portfolio at time t. The results for the three models estimated for shares in British Airways (BA) are as follows:

1981M11995M12

rt = 0.0215 + 1.491 rmt

RSS = 0.189

T = 180

1981M11987M10

rt = 0.0163 + 1.308 rmt

RSS = 0.079 T = 82

1987M111995M12

rt = 0.0360 + 1.613 rmt

RSS = 0.082 T = 98

(c) What are the null and alternative hypotheses that are being tested here, in terms of and ?

(d) Perform the test. What is your conclusion?