Quantitative

Methods in Finance
Spring 2021
Prof. Ali Ebrahimnejad

Problem set 3

You should upload a .rar or .zip file on the Courseware (CW) containing your
solutions and Python codes, named as your student number. Please note that it is
your responsibility to:

• make sure your assignments are properly submitted before Friday (02/10)
at 11:55 PM. Late assignments will NOT be accepted.
• make sure your assignments are clear and readable.
• write down the honor code on top of your assignment and be committed to
it.
Motivation
This assignment contains three empirical questions. The first one is about the
CAPM model and the issues associated with its estimation. Question two is a
comparison between NAV and price data and an exploration of mutual fund
managers’ investment skill. Question three is about the persistence of those skills.

Honor code
‫ از پاسخ تمرین سایر‬،‫اینجانب} نام و نام خانوادگی{تعهد می کنم که پاسخ تمرینها به طور کامل متعلق به اینجانب بوده و در تهیه آن‬
.‫دانشجویان استفاده نکرده ام‬
1) Download daily return data for four randomly-selected stocks from the 30 largest stocks on
the Tehran stock exchange for the last three years (99, 98, 97).
Estimate CAPM beta for each stock every year, using weekly return data (i.e. three betas per
stock), and CAPM beta of an equal-weighted portfolio.
Take a proxy for risk-free rate for each year (e.g., average annual "‫ " اخزا‬rate):
a. Are betas constant over time?
b. Repeat the CAPM regressions with an intercept. Are t-statistics of the intercepts
significant? What does it imply?
c. Calculate systematic and idiosyncratic risks for portfolio and individual stocks. What is
the difference between Unsystematic Risk for portfolio and an individual stock?

*Hint: Remember that:

Systematic Risk = β⋅σmarket
Systematic Variance=(Systematic Risk)2
Total Variance = Systematic Variance + Unsystematic Variance ⇒
Unsystematic Variance = Total Variance − Systematic Variance ⇒
Unsystematic Risk = √ (Total Variance of stock − Systematic Variance)

d. In the previous parts compare the equal-weighted portfolio and individual stock results
and discuss the Effect of Diversification.

2) Read the paper by Jensen on mutual fund performance:

Jensen, Michael C. "The performance of mutual funds in the period 1945–1964." The Journal of
finance 23.2 (1968): 389-416.
Try to replicate the key results in the paper by taking the following steps:
a. Randomly pick 20 equity funds from the list below:
http://fipiran.com/Fund/MFComparing/1
Make sure each fund has an “Age” of at least 4 years. Exclude any index funds (“ ‫صندوق‬
‫ )” شاخصی‬from your list.
b. Now, download historical NAV data for these funds from the link below and combine
them into one file. For each fund, try to get data from the inception (i.e. the longest
history possible): http://fipiran.com/DataService/MFNAVIndex
c. Calculate monthly returns from “NAVebtal” column. Make sure you use calendar months
to calculate returns (e.g. Farvardin, Ordibehesht, etc.)
d. For each fund, regress excess monthly return on TEPIX (“‫ )” شاخص کل‬excess monthly
return and report the coefficients (both beta and alpha) and the corresponding t-statistics
for each fund. (Report all results in one table with 20 rows, each row reporting results for
a single fund).
e. Draw a histogram of alphas, similar to Jensen (1968).
f. What do you conclude about the fund managers’ skills in generating alpha? How do your
results compare to those of Jensen (1968)? (Pay attention to the significance of alphas at
different levels considering the volume and precision of your data)
3) In this part we investigate the “Persistence in Mutual Fund Performance”.
a. What is the difference between ranking the funds based on their excess return or
abnormal return (alpha) ?
b. Consider again the 20 funds from the previous question. For each fund, separate the NAV
data into two same-length subperiods. Identify the “winners” (based on their two
measures of performance discussed in a) and “losers” lists in each period.
c. Do the calculations and complete the four sentences below based on excess return and
abnormal return separately:
“The probability of being a (loser/winner) in period 1 and being a (loser/winner) in period
2 is ….”
d. Given your findings in part (c), what do you think about the following hypothesis? Why
or why not? Discuss how reliable your argument is.
"Historical performance is a good predictor for future performance".