MS-FINANCE

FINANCIAL ECONOMETRICS
Fall 2016
Time: 6:30 pm 9:40 pm
Day: Thursday
Room: B-110
Course Instructor
Dr. G. SAGHIR
ghulam.saghir@ucp.edu.pk
Students Hours: 14:00-16:00 (from Monday to Friday)
Course Description:
Financial Econometrics is the intersection of statistical techniques and financial
economics. Financial econometrics provides a set of tools that are useful for
modeling financial data and testing beliefs about how markets work and prices are
formed. Conversely, new techniques in analyzing financial data can lead to
empirical facts inconsistent with existing theories, begging for new models or investment
strategies.
The course covers topics in time series analysis with an emphasis on applications rather
than statistical theory. The aim of the course is to equip students with a working
knowledge of important econometric techniques used in macroeconomics, international
finance, and financial economics.
We begin with models of time varying expected returns which are useful in formulating
expected returns. One of the most salient features of financial asset prices is
volatility clustering or prolonged periods of high volatility followed by more tranquil
periods. We next develop several modeling tools that allow us to forecast or predict risk,
or volatility, when risk is changing through time. The financial crisis highlighted
contagion or the fact that returns on assets tend to be more highly correlated in
market downturns. We introduce factor models as well as some more recent modeling
innovations that allow for the covariance between assets to change through time
possibly increasing in market downturns. Some market prices must satisfy long run
relationships. For example, the price of homes and household income must satisfy a longrun relationship in that average home prices cannot be too high relative to incomes. We
introduce a simple statistical model that can account for this type of relationship.
Teaching Objectives:
Upon completion of the course students will be able to

 Statistically describe and interpret financial data.

Apply basic models/ methods to analyze financial time series.
Model the mean behavior of financial time series.
Model the volatility in financial data and perform value-at-Risk calculations that
are used as an input into the financial decision making process.
Model the long-run relationship among financial time series.
Be proficient at econometric modeling of financial data using the software,
which is widely used in the commercial world.
Use event-study methodology in applied research.
Test the standard asset pricing models.
Investigate market interdependence (in the mean and variance equations).
Estimate linear and non-linear models.
Forecast financial data using high-level econometric techniques and measure
their effectiveness.
Who should take this class?
This course will be useful to students who plan to take empirically oriented
finance courses as well as students who want to get a solid understanding of the tools
required to analyze and model financial asset prices. The homework will be very
empirically oriented and students will get their hands dirty with data. The link
between new statistical models and implementation is emphasized throughout.

BOOKS:
Financial Econometrics:
Brooks, C. (2014), Introductory Econometrics for Finance. 3rd ed., Cambridge:
Cambridge University
Campbell, J.Y., A.W. Lo and A.C. MacKinlay (1997), The Econometrics of Financial
Markets, Princeton, NJ: Princeton University Press.
Christoffersen, P.F. (2003), Elements of Financial Risk Management. Amsterdam:
Academic Press.
Time Series Econometrics:
Enders, W. (2004), Applied Econometric Time Series, 2nd ed. New York: Wiley.
Hamilton, J.D. (1994), Time Series Analysis, Princeton, NJ: Princeton University Press.
Grading:

There will be home assignments (10%), term paper (20%), mid-term exam (20%) and a
final exam (50%).
Course Outline:
Financial Data:
Stylized facts of the financial markets data, major characteristics and puzzles, sources and
types of data, links to discussed time series models.
Financial Econometrics (Time Series analysis)
Under this there are two methods
(a) Univariate Model and (b) Multivariate Model
Univariate Model analysis time sires econometrics has the following:
Stochastic Process
Stochastic Difference Equation
Stationarity and Unit Root Tests
ARMA or ARIMA Models
ARCH and GARCH Models ( GARCH-M, TGARCH, EGARCH)
Multivariate Model analysis of time series econometrics has the following:
Simple VAR models
VARMA (vector Autoregressive Moving Average Model)
Structural VAR Model:
Impluse Response Function
Variance Decomposition Analysis
Structural Decomposition of Data
Co integration Analysis:
Engle-Granger Approach
The Johansen Approach
ADRL Approach
Panel Cointegration
Introduction to non-linear econometric models:
Bilinear models, piecewise linear models, TAR, STAR, SETAR and their application.
Kalman filter (time permitting):
State-space formulation, standard econometric model in state-space formulation,
estimation, application to market models.
Simulation Analysis:

Historical Simulations and Stochastic Simulations

Examples of the uses of financial econometrics:
(1) Testing whether nancial markets are weak-form informationally efcient
(2) Testing whether the capital asset pricing model (CAPM) or arbitrage pricing
theory (APT) represent superior models for the determination of returns on risky
assets
(3) Measuring and forecasting the volatility of bond returns
(4) Explaining the determinants of bond credit ratings used by the ratings agencies
(5) Modelling long-term relationships between prices and exchange rates
(6) Determining the optimal hedge ratio for a spot position in oil
(7) Testing technical trading rules to determine which makes the most money
(8) Testing the hypothesis that earnings or dividend announcements have no effect on
stock prices
(9) Testing whether spot or futures markets react more rapidly to news.
(10) Forecasting the correlation between the stock indices of two countries.