UNSW-FINS3640-S2,2010-Week 4

School of Banking and Finance www.banking.unsw.edu.au

FINS3640 - Investment Management Modeling
Week 4 - 11 Aug 2010
Introduction to using Stata
for Financial Modeling

Revision
Stata commands
Regression and t-test interpretation
R2
P-value
Hypothesis testing
Null hypothesis H0
Conditional testing
Binary
Visual plot analysis
Price observation, holding period return, dividend and stock split adjustments
WRDS

Multivariate Models

Capital Asset Pricing Model
Market Premium

Fama-French Three-Factor Model
Size Premium
Value Premium

Four-Factor Model
Momentum
Momentum-Driven
Portfolio Rebalancing

Five-Factor Model
Asset Growth

Generic Multivariate Model
This is what you need to build

How? Some hints:
Read contemporary research (see suggested reading list)
Retrieve & process data (in-class demonstration)
Establish hypotheses (should be from a quantitative course)
Test the hypotheses
Correlation
R2 & adjusted R2
P-value
t-value
Other econometrics indicators (chi2, autocorrelation…)
Build and optimise the model(s)

Modeling

Data Management
Wharton WRDS
French Data
Stock selection
Monthly
5-30 years

Weighting

Risk-free Rate
CAPM assumption: single risk-free rate
Is this practically true?

Statistical Testing
Multivariate regression
t-test
Visual analysis

Multicollinearity
Variables are almost linearly dependent
Large standard errors lead to insignificant t-values
Little explanatory power
Test Collinearity
Correlation matrix
Rotation of variables: R2 does not change much when one variable is dropped
Remedy
Drop collinear variable(s)

Outliers & Influential Points
Extreme values
Market crashes e.g. October 1987, PG 2010
Market capitalisation of top firms from highly concentrated indices e.g. BHP from ASX
Skews the model
'Black swans'
Identify: unusual observations on visual display
Remedies
Time series method: log normal
Exclusion of influential points

Andersen T G, Bollerslev T, Diebold F X, Wu G, 2006, 'Realized Beta: Persistence and Predictability', Econometric Analysis of Financial and Economic Time Series, Advances in Econometrics, Volume 20, 1-39, Elsevier, 2006

Binary Variables
Grouping
by

Heteroskedasticity
White 1980
Run regression
reg y x
The Het test right after running regression
hettest
Save the residual
predict res, r
Plot the residuals
plot res x
Bibliograph
http://www.polsci.wvu.edu/duval/ps602/Notes/STATA/heteroskedasticity.htm
http://web.missouri.edu/~kolenikovs/stata/Duke/class3.html
http://www.stata.com/support/faqs/stat/panel.html

Autocorrelation
Autocorrelation
ac
Partial autocorrelation
pac
Q-statistics
Correlogram
corrgram

ARIMA
Autoregressive integrated moving average
arima
predict

Reading

Reading (1)
Required Reading
Reeves J. J. 2008
Recommended Reading
Multivariate Models
Louise Swift, Sally Piff, Quantitative Methods for Business, Management and Finance, 2nd edition
John Y. Campbell, Yeung Lewis Chan, Luis M. Viceira, 2001, 'A multivariate model of strategic asset allocation'
Alvin C. Rencher, 2002, Methods of multivariate analysis

Reading (2)
Fama French
Fama, Eugene F.; French, Kenneth R. (1993). "Common Risk Factors in the Returns on Stocks and Bonds". Journal of Financial Economics 33 (1): 3–56
Fama, Eugene F.; French, Kenneth R. (1992). "The Cross-Section of Expected Stock Returns". Journal of Finance 47 (2): 427–465

Reading (3)
Momentum
Barberis, N., A. Shleifer, and R. Vishny. “A Model of Investor Sentiment.” Journal of Financial Economics, 49, 1998.
Crombez, J. "Momentum, Rational Agents and Efficient Markets." The Journal of Psychology and Financial Markets, 2, 2001.
Daniel, K., D. Hirschleifer, and A. Subrahmanyam. “A Theory of Overconfidence, Self-Attribution, and Security Market Under and Over-reactions.” Journal of Finance, 53, 1998.
Jegadeesh, N., and S. Titman. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48, 1993.
Jegadeesh, N., and S. Titman. “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations.” NBER Working paper #7159, 1999.

Reading (4)
Asset Growth
Cooper, Gulen & Schill, 2009, 'The asset growth effect in stock returns'
Business Cycle
DeStefano, Michael, 'Stock Returns and the Business Cycle'. Financial Review, Vol. 39, No. 4, November 2004
Corporate Governance
Shane A. Johnson, Ted Moorman, and Sorin Sorescu, 2005, 'Governance, Stock Returns, and Market Efficiency'

Reference
Reeves J. J. 2008
Andersen et al 2006
Heng et al 2010
http://www.polsci.wvu.edu/duval/ps791c/Notes/Stata/arimaident.html

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