BE314: Financial Modelling - Spring 2021 Coursework

In this coursework, our goal is to explore whether the returns on a portfolio of stocks can be explained by the returns on the market portfolio and three other variables.

1)On Moodle, under the 'Assessment information' section, click on the link named 'Coursework dataset allocations'.Open the Excel file that downloads, locate your student registration number in the list and note your assigned dataset number. This is the dataset you are required to use in your coursework. If for some reason your name is not on that list, email Dr Mark Hallam a..m@essex.ac.ukto find out your dataset number. Note:you will lose marks if you do not use the dataset that is assigned to you.

2)Download the Excel file that corresponds to your assigned dataset number. The files are all under 'Assessment information', and the links are in the form 'BE314 - 2021 CW dataset X'where X is your assigned dataset number from step 1.

3)You are asked to answer the questions below. Fill in this Word document and submit it as your coursework. Keep the margins of this document and the templates given underneath each question as they are and use a 11 pt. font or larger when writing up your answers. Note:you will lose marks for changing the size of the answer boxes or for badly formatted answers.

COURSEWORK QUESTIONS

1)[15 marks]In the Excel dataset filecolumn B contains gross monthly percentage returns on a portfolio of US stocks (denoted byrp), column C contains gross monthly returns on the market portfolio (denoted byrm) and column D contains monthly returns on the risk-free asset (denoted byrf). Columns E, F and G contain values for three further variables denoted by SMB, RMW and CMA, which are used in later questions.

a)Import these data into EViews with the same variable names as in the Excel file (e.g.rp,rm, etc.).

b)Generate two new series namedrp_exandrm_excontaining theexcessreturns above the risk-free rate for the industry portfolio and the market portfolio respectively (i.e. the gross portfolio returns minus the corresponding risk-free asset returns).

c)In EViews calculate the following descriptive statistics forrp_exandrm_ex: mean, standard deviation, skewness and kurtosis. Insert a table containing these values in the box below.

d)In the same box below, briefly interpret the sample values of the descriptive statistics in your table (mean, SD, skewness and kurtosis) and explain what they imply about excess returns on the two portfolios.

2)[8 marks]Estimate the following regression model using your dataset in EViews:

3)[15 marks]Interpret the estimated values of the intercept and slope coefficients and the value of R-squared, clearly explaining in each case what the value implies about the estimated relationship between the excess returns on the two portfolios. Note that all returns are in percentage terms e.g. a value of 2 corresponds to a 2% return.

4)[5 marks]Based on your estimated regression model, what is the predicted value of the excess return on the portfolio of stocks when the excess return on the market portfolio is -3%. Show your calculations/working in your answer.

5)[14 marks]Test the null hypothesis thatagainst a two-sided alternative hypothesis at a significance level of 5%. Clearly show your calculation of the test statistic and explain how you reach your conclusion. Make sure that you state the null and alternative hypotheses, the degrees of freedom used and the critical value you use. Note: you must compute the test statistic yourself using the relevant values in your regression output from Question 2 and not use the hypothesis testing feature in EViews. You may use the default EViews coefficient standard errors that are valid for the case of homoscedastic errors.

6)[8 marks]ThevariablesSMB, RMWandCMAin your dataset are three factors proposed in the finance literature for explaining excess equity returns. We now explore whether including them as additional explanatory variables will improve the ability of the model to explain portfolio returns. Estimate the following multiple regression model in EViews:

Copy and paste the EViews regression output into the box provided below:

7)[12 marks]Use the F-statistic to test the null hypothesis that the coefficients on the three new explanatory variables (SMB, RMW and CMA) added in the second model areall simultaneouslyequal to zero (i.e. whether they arejointlystatistically insignificant). Youmust calculate the F-statistic yourselfusing the formula from the lecture notes andnotuse the F-test function in EViews. Carefully state your null and alternative hypotheses, the numerator and denominator degrees of freedom and the relevant 5% critical value from the F-distribution. Clearly show how you calculate the value of the test statistic and clearly explain what the outcome of the test is.

8)[14 marks]Based on your answer to the previous questions and all other relevant information from the regression output of the two models, which of the two models is more suitable for explaining the excess returns on the portfolio? Clearlyexplain and justifyyour answer.

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