## The linear probability model

The linear probability model (LPM) is by far the simplest way of dealing with binary dependent variables, and it is based on an assumption that the probability of an event occurring, Pi, is linearly related to a set of explanatory variables x2i, x3i, , xki Pi P(yi 1) Pi + Pi X2i + Pi X3i + + PkXki + Ui, i 1, , N The actual probabilities cannot be observed, so we would estimate a model where the outcomes, yi (the series of zeros and ones), would be the dependent variable. This is then a linear...

## Info

Testing whether spot or futures markets react more rapidly to news Forecasting the correlation between the stock indices of two countries. The list in box 1.1 is of course by no means exhaustive, but it hopefully gives some flavour of the usefulness of econometric tools in terms of their financial applicability. 1.2 Is financial econometrics different from 'economic econometrics' As previously stated, the tools commonly used in financial applications are fundamentally the same as those used in...

## VAR estimation in EViews

By way of illustration, a VAR is estimated in order to examine whether there are lead--lag relationships for the returns to three exchange rates against the US dollar - the euro, the British pound and the Japanese yen. The data are daily and run from 7 July 2002 to 7 July 2007, giving a total of 1,827 observations. The data are contained in the Excel file 'currencies.xls'. First Create a new workfile, called 'currencies.wfT, and import the three currency series. Construct a set of continuously...

## Estimating exponential smoothing models using EViews

This class of models can be easily estimated in EViews by double clicking on the desired variable in the workfile, so that the spreadsheet for that variable appears, and selecting Proc on the button bar for that variable and then Exponential Smoothing____The screen with options will appear Estimating exponential smoothing models There is a variety of smoothing methods available, including single and double, or various methods to allow for seasonality and trends in the data. Select Single...

## Simultaneous equations modelling using EViews

What is the relationship between inflation and stock returns Holding stocks is often thought to provide a good hedge against inflation, since the payments to equity holders are not fixed in nominal terms and represent a claim on real assets unlike the coupons on bonds, for example . However, the majority of empirical studies that have investigated the sign of this relationship have found it to be negative. Various explanations of this puzzling empirical phenomenon have been proposed, including...

## Parameter stability tests

So far, regressions of a form such as yt Pi P2 x2t P3 x3t ut 4.61 have been estimated. These regressions embody the implicit assumption that the parameters pi, p2 and p3 are constant for the entire sample, both for the data period used to estimate the model, and for any subsequent period used in the construction of forecasts. This implicit assumption can be tested using parameter stability tests. The idea is essentially to split the data into sub-periods and then to estimate up to three models,...

## Review questions

What are the differences between autoregressive and moving average models 2. Why might ARMA models be considered particularly useful for financial time series Explain, without using any equations or mathematical notation, the difference between AR, MA and ARMA processes. 3. Consider the following three models that a researcher suggests might be a reasonable model of stock market prices a What classes of models are these examples of b What would the autocorrelation function for each of these...

## Multiple regression in EViews using an APTstyle model

In the spirit of arbitrage pricing theory APT , the following example will examine regressions that seek to determine whether the monthly returns on Microsoft stock can be explained by reference to unexpected changes in a set of macroeconomic and financial variables. Open a new EViews workfile to store the data. There are 254 monthly observations in the file 'macro.xls', starting in March 1986 and ending in April 2007. There are 13 series plus a column of dates. The series in the Excel file are...

## Ustb3m Ustb6m Ustb1y Ustb3y Ustb5y Ustb10y

And click OK, then name the group Interest by clicking the Name tab. The group will now appear as a set of series in a spreadsheet format. From within this window, click View Principal Components. Screenshot 3.2 will appear. There are many features of principal components that can be examined, but for now keep the defaults and click OK. The results will appear as in the following table. Principal Components Analysis Date 08 31 07 Time 14 45 Sample 1986M03 2007M04 Included observations 254...

## The test of significance approach

Assume the regression equation is given by yt a 3xt ut, t 1, 2, , T. The steps involved in doing a test of significance are shown in box 2.5. Box 2.5 Conducting a test of significance 1 Estimate a, 3 and SE a , SE0 in the usual way. 2 Calculate the test statistic. This is given by the formula test statistic 3 2.30 where 3 is the value of 3 under the null hypothesis. The null hypothesis is H0 3 3 and the alternative hypothesis is H1 3 3 for a two-sided test . 3 A tabulated distribution with...

## Estimation and hypothesis testing in EViews example 2 the CAPM

This exercise will estimate and test some hypotheses about the CAPM beta for several US stocks. First, Open a new workfile to accommodate monthly data commencing in January 2002 and ending in April 2007. Then import the Excel file 'capm.xls'. The file is organised by observation and contains six columns of numbers plus the dates in the first column, so in the 'Names for series or Number if named in file' box, type 6. As before, do not import the dates so the data start in cell B2. The monthly...

## Simple linear regression in EViews estimation of an optimal hedge ratio

This section shows how to run a bivariate regression using EViews. The example considers the situation where an investor wishes to hedge a long position in the S amp P500 or its constituent stocks using a short position in futures contracts. Many academic studies assume that the objective of hedging is to minimise the variance of the hedged portfolio returns. If this is the case, then the appropriate hedge ratio the number of units of the futures asset to sell per unit of the spot asset held...

## Isbn13 9780511398483 Isbn13 9780521873062 Isbn13 9780521694681

Cambridge University Press has no responsibility for the persistence or accuracy of urls for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. Preface to the second edition xix 1.1 What is econometrics 1 1.2 Is financial econometrics different from 'economic econometrics 2 1.4 Returns in financial modelling 7 1.5 Steps involved in formulating an econometric model 9 1.6...