2020 Nov ECON339 Spring Session/T3 Wollongong/PSB Academy Page 1 of 3 Faculty of Business School of Accounting, Economics and Finance Student to complete: Family name Other names Student number Table numberECON339 Applied Financial Modelling Wollongong/PSB Mock Final Examination Paper Spring/T3 2020 Exam duration 3 hours Weighting 50 % Items permitted by examiner UOW approved calculator Aids supplied None Directions to students Answer ALL questions in Sections A and B. This test is graded out of 50: Section A – 15 marks, Section B: B1 – 20 marks and B2 – 15 marks. Submit your answer in WORD document through Turnitin on the Moodle page. This exam paper must not be removed from the exam venue
2020 Nov ECON339 Spring Session/T3 Wollongong/PSB Academy Page 2 of 3 Section A. Answer all questions. (15 marks, 1 mark each) 1. Violating which of the classical linear regression model assumption will lead to a biased OLS estimator? [1] 2. In a system of equations given below, Y’s are endogenous while X’s are exogenous. Which of the equation is just identified? Explain. [2] 3. State one advantage of using a Vector Autoregression (VAR) model. [1] 4. In the following VAR model, write down the null hypothesis for the Granger causality test of ݕଶdoes not Granger cause ݕଵ? [1] 5. In a VAR model, name the method of analysing the proportion of the movements in the dependent variables that are due to their “own” shocks, versus shocks to the other variables. [1] Section B. Answer ALL questions (35 marks) Question B1 (20 marks) In the paper on the “Overreaction Hypothesis and the UK Stock Market” by Clare and Thomas (1995), the authors employed monthly UK stock returns from January 1955 to December 1990 on all firms traded on the London Stock exchange to run a regression where WtpLtptD RRR,,, R denotes the monthly average excess return over the stock market and tde notes the 18 independent tracking periods. LtpR, and Wtp R, are the loser’s and winner’s portfolio returns respectively. (a)State the overreaction hypothesis and how can one use regression (B1-1) to test for the overreaction hypothesis? [2] (b) Suppose the loser stocks are generally more risky, explain the drawback of using regression (B1-1) when testing the overreaction hypothesis. How would you correct for it? [2] Using the data employed by Clare and Thomas (1995), suppose you are interested in analyzing whether there are quarterly return differences between the loser and winner portfolios. You estimated the following regression by OLS:
2020 Nov ECON339 Spring Session/T3 Wollongong/PSB Academy Page 3 of 3 where WtpLtptDRRR,,,, R denotes monthly excess return over the stock market, iQ is a dummy variable for i=1, 2 and 3 such that Qif return is in the i-th quarter and 0 otherwise. The result is What is the difference in the mean return between the first and second quarter? [1] (d)Now define a fourth quarter dummy as Q,41 if return is in the fourth quarter and 0 otherwise. Suppose you drop the first quarter dummy from regression (B1-2) and include the fourth quarter dummy instead such that (B1-3) What will the estimated value of now be? [4] (e)Can one run the following regression titiitDuQR 41,,(B1-5) to analyse whether there are quarterly return differences between the loser and winner portfolio? Explain. [2] Question B2 (10 marks) In the paper by Terence C. Mills and Alessandra G. Mills (1991) on “The International Transmission of Bond Market Movements”, they investigate the relationships between the government bond yield of four countries, namely the US, the UK, West Germany (WG) and Japan. Mills and Mills (1991) performed unit root tests on each of the four countries bond yield and found the yield to be an I(1) process. They also performed a cointegration test on all four countries bond yield but failed to find any cointegrating relationships amongst them. They then estimated a Vector Autoregression (VAR) of lag order 8. To generate variance decompositions from their model, they considered two Cholesky orderings: the first ordering (I) is (US, UK, WG, Japan) and the second ordering (II) is (Japan, UK, WG, US). (a) What is the pre-requisite of the variables for a cointegration relationship to exist between them? [1] (b) Suppose you believe that the US and UK bond prices possess a long-run relationship. Explain how you can undertake a formal test on this conjecture. [5] (c) Write out the system of four regressions involving the four countries bond yield. For purpose of exposition and simplicity of notation, use only one 1 lag and let ri denote the yield for country i= US, UK, WG and JP. [2] (d) What is the rationale of using the second ordering when presenting the impulse responses results? [1]