Description

This model will try to estimate the price change for an oil company given the change in various inputs that determine the value of the companys stock. The following variables will be used: Dependent: OILSTOCK price of the oil companies stock Independent: CRUDEOIL the price of crude oil, we would expect the price of the stock to rise as crude oil rises in price (expected sign: +) SP500 how the overall market performs, we would expect this stock to rise when the overall market is rising (expected sign: +) TENYEAR change in interest rates, if interest rates go up we would expect the price of the stock to fall since it will cost more to borrow money for operations (expected sign: +) *note the sign should be positive because if interest rates go up the ETF price falls Proposed Model:

Data
Source: Yahoo! Finance Just by peering at the chart we can see that Exxon mobile and crude oil look both highly correlated with one another. Running a correlation tables confirms this, in fact almost all variables look to be highly correlated. This could possibly be a model that will be plagued by a collinearity problem. The data is recorded in price per share, ETFs for the commodities were used to simplify any conversion factors from yields or contract sizes.

Exxon Mobile Exxon Mobile Crude Oil ETF SP500 ETF Ten Year ETF

Crude Oil ETF

SP500 ETF

Ten Year ETF

1 0.777599255 1 0.904667371 0.795545553 1 0.671997044 0.819762306 0.776714065

Outright Prices 1/1/2011 - 11/29/2011

160 140 120 100 80 60 40 20 0 Exxon Mobile Crude Oil ETF SP500 ETF Ten Year ETF

Regression Results
Regression Statistics Multiple R 0.91430447 R Square 0.835952664 Adjusted R Square 0.833775044 Standard Error 0.022381573 Observations 230 ANOVA df Regression Residual Total 3 226 229 Coefficients Intercept ln(Crude) ln(SP) ln(10yr) -1.411818455 0.058996178 0.970597721 0.187484255 SS MS F 0.57690213 0.19230071 383.8837134 0.113211264 0.000500935 0.690113394 Standard Error 0.40250084 0.014878376 0.056532519 0.050752803 t Stat P-value

3.507616171 0.000545362 3.965229758 9.84175E-05 17.16883919 7.58385E-43 3.694067039 0.000276848

All variables align with the initial fundamental model and all are significant at the 95% level. If there were collinearity problems in the model the t-stats would not be so high, since the correlation table showed some very large correlations we will have to confirm that there is not extreme heteroskadacity skewing our t-stats. R-Squared and adjusted R squared are both very high. The adjusted R squared is not very different from R-Squared due to the fact that the estimators have such high significance (low variance).

F-Test
H0: CRUDE = SP = 10YR = 0 HA: H0 not true ESS = 0.5769021 RSS = 0.113211264 N =230 K =3 F = (0.5769/3) / (0.1132/ (230 3 1)) = 383.9204947

F > F* = 383 > 2.6 Reject H0, the estimators are overall significant from zero. The f-statistic is extremely large, agreeing with the fact that all of the individual estimator t-stats are significant as well. If there was a collinearity problem we would be seeing such large significance in the t-statistics unless a severe amount of heteroskadacity is masking the true t-stats.

Violations of the Classical Assumption Multicollinearity:

R-Squared = 0.8359 Variance Inflation Factor: 1/ (1-0.8359) = 6.095801505 The variance inflation test indicates that there is a severe amount of collinearity in the model, this will cause out estimates to high a higher variance, however the t-stats of our estimators have not been affected by this severe collinearity, perhaps there is heteroskadacity skewing the t-stats?

Heteroskadacity:
Guessing what variable is causing the heteroskadacity will be difficult since it is common for a security price to have changing variance over time (volatility). I believe that the digest cause of volatility would have to be the market in general, or the SP500, so that will set a Z in the park test. Park Test:
Coefficients 0.005003881 -0.000932793 Standard Error t Stat P-value 0.004992978 1.002183665 0.317317317 0.001032255 0.903646148 0.367136819

Intercept ln(SP)

Since the SP t-stat is not significant at the 95% level the park test indicates that the model is not plagued by a heteroskadacity problem.

White Test: H0: No heteroskadacisty HA: Heteroskadactiy N = 230 R-Squared = 0.2668 Df = 9 ChiCritical = 16.92 Chi-stat = 61.36 Reject H0, it is likely that there is heteroskadacity. *It is likely that another factor was causing the heteroskadacity city rather than the SP like I originally hypothesized, since the white test tests all proportionality factors.

Serial Correlation:
Durbin-Watson d Test Sum Lagged Error = 0.0145 Sum Error-Squared = 0.11298 D-Stat = 0.0145/0.11298 = 0.128343 H0: p = 0 HA: p != 0 K=3 N = 230 DL = 1.69 DU = 1.85 Since D < DL Reject H0, there exists serial correlation. A possible cause of the serial correlation could be from an omitted variable.

Model Improvements
To improvise the model Ive introduced a dummy seasonality factor. During the summer vacation months consumers drive more and thus use more fuel, increasing demand for oil. Perhaps this could be an omitted variable that will help cure the collinearity problem. Each month will take the following definition: January Non summer Febuary Non summer March Non summer April Non summer May - Summer June - Summer July - Summer August - Summer September Non summer October Non- summer November Non summer Another dummy variable gauging economic conditions will be added. This dummy variable will be 1 if Non-Farm payrolls for the month is greater than the last and will be 0 if NFP is decreasing. New proposed Model:
+

Expected sign of new Season dummy variable: + The season dummy variable should increase the share price of the oil companies stock, since demand for oil increases during the summer months. Expected sign of new NFP dummy variable: + The Non-Farm payrolls dummy variable should be positive since an increase in economic activity should increase the demand of oil.

Modified Regression Results

-0.2 -0.2 0 SUMMARY OUTPUT R 4.8 4.4 4.5 0

N S l

N S l

Regression Statistics Multiple R 0.933846593 R Square 0.872069459 Adjusted R Square 0.869213867 Standard Error 0.019852872 Observations 230 ANOVA df Regression Residual Total Coefficients Intercept ln(Crude) ln(SP) ln(10yr) Summer NFP -2.2429337 0.019785033 1.155958547 0.205593733 -0.020005418 0.014218742 5 224 229 SS MS F 0.601826814 0.120365363 305.3900305 0.08828658 0.000394137 0.690113394 Standard Error 0.374268097 0.014088837 0.055563113 0.045212015 t Stat P-value

5.992853037 8.15932E-09 1.404305615 0.161612888 20.80442362 3.08601E-54 4.547325121 8.89615E-06 0.002978617 6.716345443 1.51654E-10 0.002720242 5.227012843 3.94165E-07

The summer dummy variable did not align with fundamental insight, however the nonfarm payrolls number did. Possible explanations for the mis-alignment in the seasonal variables sign could be due to the size of the sample size. The sample is only taken for one year; seasonality might only be observable over multiple years. The adjusted R-squared has increased as a results of adding the dummy variables.

Restricted F-Test H0: HA: At least on != 0 RSSu = 0.60182681 RSSr = 0.57690213 N= K= K1 =

Final Improved Model

Conclusion Can we make money trading this model?