UNIVERSITY OF MAURITIUS FACULTY OF SCIENCE S YEARLY/SECOND SEMESTER EXAMINATIONS MAY 2017 PROGRAMME BSc (Hons) Mathematics with Finance - Year 3 | BSe (Hons) Mathematics with Statistics - Year 3 MODULE NAME _ | Statistical Methods for Finance QUESTIONS SET TO BE ATTEMPTED DATE ‘Thursday MODULE CODE MA 3005(5) | 18 May 2017 TIME 09:30 - 11:30 Hours | DURATION 2Hours NO. OF : NO. OF QUESTIONS INSTRUCTIONS TO CANDIDATES There are 2 Sections in this paper: Section A and Section B. Section A consists of 1 Question. Question 1 is COMPULSORY. Section B consists of 3 Questions. Answer ANY TWO (2) Questions. All Questions carry equal marks.STATISTICAL METHODS FOR FINANCE = MA 30: SECTION A (Compulsory: Question One (1)) Question 1 (@) An investor will place one-third of his money into security S,, one-sixth into security >, and the remainder into security 53. Security data is given in the table below: Covariance Matrix Security, 5; | Elrs,] Si Sa S3 Sy 0.25 09 0.045 0.05 Sy 01S | 0.045 | 0.07 | 0.04 Ss 035 | 005 | 004 | 0.06 Find the expectation and variance of the return, 7, for this three-asset portfolio. [244 marks] (b) A simulation of 2000 independent sets of identically and independently distributed standard normal random numbers, with 50 observations in each set, was generated. ‘The maximum absolute correlation obtained among all pairs of sets was 0.66, Comment on this result and what do we expect to see if there are 20,000 such independent sets? [4 marks] (©) The optimal weights of two efficient portfolios each consisting of six positively correlated assets, with target monthly return of 1.2% and allowing short selling but no riskless asset, were calculated using the estimated expected retum and covariance matrix, based on the first 48 observations and the next 48 observations of its time series respectively. The fol- Jowing table reports the weights and the corresponding portfolio risks. Assets ] Observations Taken [1 2 3 4 5 | 6 | Portfolio Risk First 48 Obs, 0.275 |-0.118 | 0.098 | -0.134 | 0.053 |w,, 0.042 ‘Next 48 Obs. + -0.035 | 0.003 | 0.200 | -0.001 | -0.124 [wy 0.022 @ Find wa and wp and explain the results ii) Discuss why the portfolios cannot hedge the risk very efficiently. [6 +2 marks] (Question 1 Continue)STATISTICAL METHODS FOR Fi eee) (@) Consider a GARCH(1,1) model %= 0.0076 +a, =H, eri.id (0,1), of = 0.0012 + 0,85402., + 0.127474, @ Suppose at the forecast origin t = A, 6, = 0.052 and a, = —0.013. Compute the Volatility forecast for the time t =h + 1andt=h+2. [5 marks] i) State any weakness of the above model, [2 marks] (End of Question 1) Page 2 0f6FOR FINANCE oe SECTION B (Answer any Two (2) Questions out of Three (3) Questions) Question 2: (a) Define the pth degree truncated power function at a knot ¢. [2 marks] (b) Sketch the spline function given by s(x) = —2x + (x — 3),,x € [0,5] [3 marks} (©) The following table shows mutually independent observations: x] 2] ]0] 1] 2 y[alt [2/4] 2 Consider fitting a nonparametric regression model Y= Bot Bixt Box-D+ te, where e~N(0, 0%). (i) Write the model matrix, X and verify that 03 01 —05 Ox =] 01 02 -05 05 -05 25 [2+4 marks] Fit the nonparametric regression model. (3 marks] (ii) Draw the scatter diagram and superimpose the fitted model on your diagram. [3 marks} (iv) Test the significance of the model at the 5% level by first developing the ANOVA ta- ble given that F(a =0.05,3,1) = 215.7, F(a =0.05,3,2) = 19.2, F(a = 0.05, 2,2) = 19.0. [5 marks] (v) Caloulate a 95% confidence interval for Bz. Is there sufficient evidence to conclude that the knot at x = 1 is required? [3 marks] (End of Question 2)STATISTICAL METHODS FOR FINANCE — MA 3005 Question 3: a. Consider the parametric efficient portfolio problem for a universe of n risky assets with @ Gi) some nonnegative parameter ¢ given by = min {ous $yx'Sx |x = where Lis a vector of ones, 4 = [H]imim is the expected return vector, i], jam i8 the covariance matrix, [*:]ieim is the proportion vector of wealth to be invested in the assets, Using optimality conditions, prove that the efficient frontier described by (op, tp) is given by oh = py + He a by first deriving the efficient portfolios x, z, and o} in terms of the parameter ¢ and giving the expressions for a, a and Bo, Sketch the efficient frontier using the mean-variance space indicating clearly the global minimum variance portfolio. [15 +2 marks} b. Consider the case n = 3 assets with 1. 0.01 a=(12) z=( 0.05 ) 1.3. 0.07: Find the efficient frontier. [8 marks] (End of Question 3) Page 4 of 6STATISTICAL Mi HODS FOR FINANC! Question 4: a. Give the four stylized facts that distinguish financial time series from other time series data {4 marks] b. Consider the ARCH(1) model as follows: Dy = OE, Got+ayar,, a>0, a20, where €; ~ i.i.d (0,17). Let F;_1 denote the information set available at time t — 1 (i) Derive the unconditional expectation, E(a,) and the unconditional vari ance, Var(a,). State the condition required for Var(a,) to be finite and positive. Gi) Prove that the unconditional kurtosis of ay is 30-42) 1-3a?~ [5+6 marks] ¢. The monthly log returns, in percentages, of the ABC stock from January 1960 to Decem- ber 2009 were analysed and the edited R output on Page 6 is given. Use the output to an- swer the following questions: @ Test the claim that the mean of the log retum series is zero. (1 mark] (ii) Test for any serial correlation in the monthly log returns at the 5% significance level. [2 marks] Test for any ARCH effect in the monthly log returns by stating the hypotheses. [2 marks} (iv) A GARCH(1, 1) model with Gaussian distribution is used for the volatility equa- tion. Write down the fitted model, including the mean equation and explain why the model is not adequate. B marks] (v) Apart from the inadequacy in (iv), is the fitted GARCH(1, 1) model adequate? Why? 2 marks] (PLEASE TURN OVER) Page $ of 6‘ead. table( “data. txt", header=T) ‘o=log(da$ko+1)*100 # Percentage Tog returns > t.test(ko) One Sample t-test data: ko t = 4.3938, df = 599, p-value = 1.318e-05 alternative hypothesis: true mean is not equal to 0 95 percent confidence interval: 0.6206257 1. 6238744 sample estimates: mean of x: 1.13225 > di > ke > Box. test (ko, lag=24, type='Ljung') Box-Ljung test data: ko x-squared = 25.516, df = 24, p-value = 0.3782 > ateko-mean(ko) : > Box. test (atA2, 1ag=24, type=" Ljung") Box-Ljung'test data: ata2 X-squared = 194.08, df = 24, p-value < 2.2e-16 > library (fearch) > ml=garchFit @~garch(1,1) ,data=ko, trace=F) > summary (m1) Title: GARCH Modelling call:” garchFit(formula = ~garch(1, 1), data = ko, trace = Mean and variance Equation: data ~ garch(1, 1) [data = ko} Conditional Distribution: norm coef ficient(s): mu omega alphal beta 1.292783 2.652907 0.094074 0.835082 std. Errors: based on Hessian Error analysi Estimate std. error t_value Pr(>it|) mu 1.29278 0.23313 5,545.2. 940-08 =*= omega 2.65291 0.90419 2934 0.00335 «= alphal 0.09407 0.02195 4.285 1.82e-03 ##* betal 0.83508 == 003420241420 < 2e-16 #** signif. codes: 0 '***" 0.001 '**" 0.01 “** 0.05 '.' 0.2 Log Likelihood: -1915.492 normalized: -3.192487 Standardised Residuals Tests: . Statistic p-value Jarque-gera test 2 chiA2 76. 74663, Shapiro-wilk Test RW 0.9831763 2.118411e-06 Ujung-Box Test —R © Q(10) 9.616641 014747453 Ljung-Box Test RR QC15)_ 19.0554 02112342 Ljung-gox Test = R_-O(20 2131853 013786019 Ujung-Box Test RAZ Q¢10)_ 11:74956 013021669 Ljung-Box Test —-RAZ_QC15)_ 12163524 06304484 Ujung-sox Test —RA2-_Q(20) 1319141 018348244 LM arch Test R TRA2” 10.40465 015805065, Information Criterion statistics: AIC Bic SIC Hore 6.398308 6.427621 6.398220 6.409719 Pages of 6 5) End of Paper—————~Percentage Points of Student’s t Distribution This table gives percentage points of the t-distribution on v df. These are the values of + for which a given percentage, P, of the t-distribution lies outside the range -t to +1. As the mumber of degrees of freedom increases, the distribution becomes closer to the standard normal distribution, z i 02 Or 318 «637 318637 66 992 8 51g 454 584 «602 18 375 460 7.17 8.61 33600 4.03 5.89. 6.87 314 371 S21 5.96 300. 350 4B Ai 290 326 450 504 282 «305 «4504 78 2760 7a ais 272 311 4034.44 268 3.05 3.93 4.32 265 3.01 3.85 4.22 262 28 39 4h 260 295 373 + 407 258 2923.69 4.01 257 290 3.65 (3.96 255° 288 = 3.61 3.92 254 | Oise: 358 | aise: ost i aies 655 gigs 251} Higa at Bil cia, 249° 280 3.47 3.75 248 248 34k aia Bat 4 He 1 ai aie? BAG ee OPS sao Teta 350068 1.31 (69) 203-944 BD aad 50 40 068 = 1.30 1682.02 242270331 3.55 a5 O68 | 30 ed BO ST eb aR 3iga SON scioR ag cies sean ahaa stg epit gig ts as BS GR ag eT) 4200 ia) ier sas (alae, 6 (068 MBO sey 24 200s gai deer 4 gst tage oo OST MB ed Gs) ese 38 abeTHE NORMAL DISTRIBUTION FUNCTION If Z has a normal distribution with mean 0 and variance 1 then, for each value of z, the table gives the value of ©(z), where ©@)=PZ <2). For negative values of z use @(—z) Oe). _ 123456789) z| 0 1 Meier: See Oc, GRtae SSE CHEMSEeeatoeeeee Helena) aon [0.0] 0.5000 [0.5040 0.5080 0.5120] 0.5160 0.5199 0.5239]05279 03319 0.5359] 4 B 12|16 20 24]28 32 36 0.1] 0.5398 | 0.5438 0.5478 0.5517] 0.5557 0.5596 0.5636} 0.5675 0.5714 0.5753] 4 8 12|16 20 24128 32 36 0.2] 0.5793 | 0.5832 0.5871 0.5910] 0.5948 0.5987 0.6026 | 0.6066 0.6103 0.6141| 4 8 12|15 19 23)27 31 35 0.3} 0.6179 | 0.6217 0.6255 0.6293 | 0.6331 0.6368 0.6406 | 0.6443 0.6480 0.6517] 4 7 11/14 18 22)25 29 32 [0.4] 0.6554 | 0.6591 0,6628 0.6664 | 0.6700 0.6736 0.6772} 0.6808 0.6844 0.68794 7 11]14 18 22|25 29 32, 0.5] 0.6915 | 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 | 0.7157 0.7190 0.7224|3 7 10)14 17 2024 27 31 0.6] 0.7257 | 0.7291 0.7324 0.7357] 0.7389 0.7422 0.7434] 0.7486 0.7517 0.7549] 3 7 10]13 16 19]23 26 29 0.7} 0.7580] 0.7611 0.7642 0.7673 | 0.7704 0.7734 0.7764] 0.7794 0.7823 0.7852/3 6 912 15 18]21 24 27 0.8] 0.7881 | 0.7910 0.7939 0.7967 | 0.7995 0.8023 0.8081 | 0.8078 0.8106 0.8133/3 5 811 14 16]19 22 25 0.9] 0.8159) 0.8186 0.8212 0.8238 | 0.8264 0.8289 0.8315] 0.8340 0.8365 0.8389/3 5 8/10 13 15|18 20 23 1.0] 0.8413 | 0.8438 0.8461 0.8485] 0.8508 0.8531 0.8554 | 0.8577 0.8599 0.8621/2 5 7/9 12 14/16 19 21 1.1] 0.8643 | 0.8665 0.8686 0.8708 | 0.8729 0.8749 0.8770| 0.8790 0.8810 0.8830/2 4 6|8 10 12)14 16 18 1.2/ 0.8849 | 0.8869 0.8888 0.8907] 0.8925 0.8944 0.8962 | 0.8980 0.8997 0.9015]2 4 6]7 9 11]13 15 17 1.3} 0.9032 | 0.9049 0,9066 0.9082 0.9099 0.9115 0.9131 |0.9147 0.9162 0.9177|2 3 s|6 8 10111 13 14 1.4] 0.9192 | 0.9207 0.9222 0.9236 | 0.9251 0.9265 0.9279 | 0.9292 0.9306 0.9319|1 3 416 7 slio113 1.5} 0.9332 | 0.9345 0.9357 0.9370 | 0.9382 0.9394, 0.9406 [0.9418 0.9429 0.9441/1 2 4/5 6 7/8 1011 1,6] 0.9452 | 0.9463 0.9474 0.9484] 0,9495 0.9505 9.9515 /0.9525 0.9535 0.954311 2 3]4 5 6/7 8 9 1.7] 0.9554 | 0.9564 0.9373 0.9582] 0.9591 0.9599 0.9608 | 0.9616 0.9625 0.9633|1 2 3/4 4 5/6 7 8 1.8) 0.9641 | 0.9649 0.9656 0.9664 | 0.9671 0.9678 0.9686 | 0.9693 0.9699 0.9706|1 1 2/3 4 4|si6 6 1.9] 0.9713 | 0.9719 0.9726 0.9732] 0.9738 0.9744 0.9750 |0.9756 0.9761 0.9767/1 1 2/2 3 4]4 5 5 2.0} 0.9772 | 0.9778 0,9783 0.9788 | 0.9793 0.9798 0.9803 | 0.9808 0.9812 0.9817/0 1 1|2 2 3/3 4 4 (2.1) 0.9821 | 0.9826 0.9830 0.9834 | 0.9838 0.9842 0.9846 |0.9850 0.9854 0.985710 1 112 2 2/3 3. 4 2.2) 0.9861 | 0.9864 0.9868 0.9871 | 0.9875 0.9878 0.9881 | 0.9884 0.9887 0.9890]0 1 1|1 2 2/2 3 3 2.3} 0.9893 | 0.9896 0.9898 0.9901 | 0.9904 0.9906 0.9909]0.9911 0.9913 0.9916{0 1 1/1 1 212 22 2.4] 0.9918 | 0.9920 0.9922 0.9925 | 0.9927 0.9929 0.9931] 0.9932 0.9934 0.99360 0 1/1 1 1/1 2 2 2.5] 0.9938 | 0.9940 0.9941 0.9943 | 0.9945 0.9946 0.9948 10.9949 0.9951 0.9952/0 0 of1 4 i{t 1 1 2.6| 0.9953 | 0.9955 0.9956 0.9957} 0.9959 0.9960 0.9961 | 0.9962 0.9963 0.99640 0 o|o 1 1/1 11 2.7] 0.9965 | 0.9966 0.9967 0.9968 | 0.9969 0.9970 0.9971 | 0.9972 0.9973 0.99740 0 0/0 0 1/1 1 1 [2.8] 0.9974 | 0.9975 0.9976 0.9977 | 0.9977 0.9978 0.9979 | 0.9979 0.9980 0.998110 0 0/0 0 ala 1 1 2.9] 0.9981 | 0.9982_0,9982_0.9983 | 0.9984 0.9984 0.9985 | 0.9985 0.9986 0.99860 0 o|o 0 0/0 0 0 Critical values for the normal dist: If Z has a normal distribution with mean 0 and variance 1 then, for cach value of p, the table gives the value of z such that P(ZS z)=p. 0.75 0.90 0.95 | 0975 0.99 0.995 | 0.9975 0.999 0.9995 | 0.674 1.282 1645 | 1.960 2.326 2.576 | 2.807 3.090 3.291