Statistics and Financial Econometrics

SAMPLE PAPER

Date Venue Time

Examiner Dr. Damien Cassells

Instructions to Candidates:
The examination is TWO hours in duration
Answer any four questions, all questions carry equal marks.
The points indicate the maximum score on each question. Allocate your time accordingly.

Materials permitted for this examination:

Calculators are permitted and relevant tables are attached to the examination paper.

You may not start this examination until you are instructed to do so by the invigilator
1. An undergraduate finance student was interested in the relationship between petrol
consumption, taxation on fuel and the number of vehicles registered in a region and gathered
data on the 50 US states. She estimated the model using Ordinary Least Squares (OLS) in
EVIEWS, some of the results from which are presented below.

Dependent Variable: PCON

Method: Least Squares

Date: 09/22/16 Time: 17:16

Sample: 1 50

Included observations: 50

Variable Coefficient Std. Error t-Statistic Prob.

C 551.6880 186.2709 2.961750 0.0048

TAX -53.59101 16.85588 -3.179365 0.0026

REG 0.186132 0.011719 15.88302 0.0000

R-squared 0.866368 Mean dependent var 603.7000

Adjusted R-squared 0.860682 S.D. dependent var 677.8267

S.E. of regression 253.0010 Akaike info criterion 13.96279

Sum squared resid 3008447. Schwarz criterion 14.07751

Log likelihood -346.0697 Hannan-Quinn criter. 14.00648

F-statistic 152.3567 Durbin-Watson stat 2.197170

Prob(F-statistic) 0.000000

(a) Write down and explain a theoretical equation that will represent the model estimated
above.
(5 Marks)

(b) Comment on the goodness of fit of the model, make sure to explain what this measure is
attempting to achieve.

(5 Marks)

(c) Test the ‘TAX’ coefficient using the 5% level of significance.

(10 Marks)

(d) Use the P-value (‘Prob.’ in EVIEWS) to comment on the ‘REG’ coefficient.

(5 Marks)

(e) Construct and interpret a 90% confidence interval on either of the two coefficients.

(10 Marks)

(f) Comment on the use of OLS for this particular model.

(15 Marks)
TOTAL 50 Marks

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2. Select any econometric model that you have studied during your current or past
studies and answer the following questions based upon this model. Ensure to use
equations and to cite relevant journal articles where necessary.

(a) Write down and explain a regression equation that would allow you to estimate
this model, explaining the functional form selected.

(10 Marks)

(b) Explain and describe what data you would need to carry out this study.

(5 Marks)

(c) How was the model estimated (e.g. a Logit model) and discuss the selection of this
estimation procedure.

(10 Marks)

(d) Discuss any econometric testing issues that you would expect to encounter with
this model, explaining why such issues would arise with your model and how you
would test for the issue.

(15 Marks)

(e) Assuming the econometric issue that you tested for in part (d) was present in your
project, explain how you would solve the issue arising.

(10 Marks)
TOTAL 50 Marks

3. (a) Describe with the aid of equations and diagrams the difference between a
deterministic and stochastic model.
(10 Marks)
(b) Discuss with the aid of equations the role of Generalised Least Squares (GLS) in
econometrics.
(10 Marks)

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(c) Below is output from EVIEWS where a test has been carried out for stationarity on
data from the Dow Jones index. Interpret the outcome of this test ensuring to set up
the null and alternative hypothesis initially.
(10 Marks)

Null Hypothesis: DOW_JONES has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -2.234873 0.1973

Test critical values: 1% level -3.588509
5% level -2.929734
10% level -2.603064

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(DOW_JONES)
Method: Least Squares
Date: 11/04/16 Time: 17:09
Sample (adjusted): 4/04/2016 6/03/2016
Included observations: 44 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

DOW_JONES(-1) -0.212889 0.095258 -2.234873 0.0308

C 3783.456 1692.850 2.234962 0.0308

R-squared
Adjusted R-squared 0.106281
0.085002 S.D.Mean
dependent0.325227
var 112.8256
S.E. of regression 107.9239 dependent
Akaike info criterion 12.24512
Sum squared resid 489198.0 var criterion
Schwarz 12.32622
Log likelihood -267.3926 Hannan-Quinn criter. 12.27519
F-statistic 4.994658 Durbin-Watson stat 2.216785
Prob(F-statistic) 0.030802
Null Hypothesis:
DOW_JONES has a
unit root

(d) Explain the use of first differencing for time series data.
(10 Marks)
(e) Explain with the aid of equations and diagrams the uses of interaction terms in
econometric modelling.
(10 Marks)

TOTAL 50 Marks

Page 4 of 12
4. (a) Explain using equations what the implications are for the Ordinary Least Squares
(OLS) estimates of a model that has an omitted variable.
(10 Marks)

(b) Show with the aid of equations how the Durbin Watson test can be used to test a
set of residuals for the presence of serial correlation.

(10 Marks)
(c) Demonstrate with equations how the volatility of a variable is modelled in the
Generalised Autoregressive Conditional Heteroskedasticity (GARCH) model.

(10 Marks)
(d) Explain with the aid of equations how to test a financial series for potential ARCH
effects.

(10 Marks)

(e) A student was conducting research using panel data and carried out a Hausman
test. A summary of the results from the test is presented below.

Correlated Random Effects - Hausman Test

Equation: Untitled
Test cross-section random effects

Chi-Sq.
Test Summary Statistic Chi-Sq. d.f. Prob.

Cross-section random 10.356588 1 0.0005

Based upon these results and focusing upon panel data, what conclusion can you
draw? Make sure to set up a null and alternative hypothesis for the test.

(10 Marks)
TOTAL 50 Marks

Page 5 of 12
5. (a) Explain the use of the Logit model in financial econometrics. Use existing literature
to provide an example of where the model has been applied.
(10 Marks)
(b) Describe with the aid of equations how to test residuals for the presence of
heteroskedasticity.
(10 Marks)
(c) Explain the role of the Ramsey RESET test in financial econometric modelling and
using equations demonstrate how the test is constructed.
(10 Marks)
(d) Explain with the aid of equations and existing literature when an Ordered Probit
model would be required in econometrics.
(10 Marks)
(e) An undergraduate student estimated equation (1) below and wanted to check the
independent variables for the presence of multicollinearity. Explain with the aid of
equations how the student could check for this issue.

Yt = α + β1X1t + β2X2t + εt (1)

(10 Marks)

TOTAL 50 Marks

Page 6 of 12
 Formulae

R2 = ESS/TSS

Adjusted R2 = 1-(1-R2)(n-k/n-k-1)

Confidence Interval (CI): CI (β) = β ±[Standard Error of β]*[Critical Value]

Ramsey Statistic (F): F = [(RSS1 – RSS2)/m]/[RSS2/(n-k-1)]

𝑡 2)
Durbin Watson Statistic (d): 𝑑 = ∑𝑡=2∑(𝑒𝑇𝑡 −𝑒𝑒𝑡−1
2
)

𝑡=1 𝑡

Page 7 of 12
 F-Tables

Page 8 of 12
 T-Tables

Page 9 of 12
Chi-Square Distribution Tables

Page 10 of 12
Durbin-Watson Tables

Page 11 of 12
Dickey-Fuller Critical Value Tables

Page 12 of 12