This document provides an introduction to using Stata for financial modeling. It discusses various multivariate models including the CAPM, Fama-French 3-factor model, 4-factor model, and 5-factor model. It also covers topics like data management, statistical testing, and addressing issues like multicollinearity, outliers, autocorrelation, and heteroskedasticity. Suggested readings on multivariate models and factors like momentum, asset growth, and corporate governance are also provided.

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

2. FINS3640 - Investment Management ModelingWeek 4 - 11 Aug 2010Introduction to using Stata for Financial Modeling

3. RevisionStata commandsRegression and t-test interpretationR2P-valueHypothesis testingNull hypothesis H0Conditional testingBinaryVisual plot analysisPrice observation, holding period return, dividend and stock split adjustmentsWRDS

4. Multivariate Models

6. Capital Asset Pricing ModelMarket Premium

8. Fama-French Three-Factor ModelSize PremiumValue Premium

10. Four-Factor ModelMomentumMomentum-Driven Portfolio Rebalancing

12. Five-Factor ModelAsset Growth

15. Generic Multivariate ModelThis is what you need to build

16. 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 hypothesesCorrelationR2 & adjusted R2P-valuet-valueOther econometrics indicators (chi2, autocorrelation…)Build and optimise the model(s)

18. Modeling

19. Data ManagementWharton WRDSFrench DataStock selectionMonthly5-30 years

20. Weighting

21. Risk-free RateCAPM assumption: single risk-free rateIs this practically true?

23. Statistical TestingMultivariate regressiont-testVisual analysis

24. MulticollinearityVariables are almost linearly dependentLarge standard errors lead to insignificant t-valuesLittle explanatory powerTest CollinearityCorrelation matrixRotation of variables: R2 does not change much when one variable is droppedRemedyDrop collinear variable(s)

25. Outliers & Influential PointsExtreme valuesMarket crashes e.g. October 1987, PG 2010Market capitalisation of top firms from highly concentrated indices e.g. BHP from ASXSkews the model'Black swans'Identify: unusual observations on visual displayRemediesTime series method: log normalExclusion of influential points

27. 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

28. Binary VariablesGroupingby

29. HeteroskedasticityWhite 1980Run regressionreg y xThe Het test right after running regressionhettestSave the residualpredict res, rPlot the residualsplot res xBibliographhttp://www.polsci.wvu.edu/duval/ps602/Notes/STATA/heteroskedasticity.htmhttp://web.missouri.edu/~kolenikovs/stata/Duke/class3.htmlhttp://www.stata.com/support/faqs/stat/panel.html

30. AutocorrelationAutocorrelationacPartial autocorrelationpacQ-statisticsCorrelogramcorrgram

33. ARIMAAutoregressive integrated moving averagearimapredict

34. Reading

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

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

37. Reading (3)MomentumBarberis, 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.

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

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