Aswini Bajaj

CFA, FRM, CA, CS, FM, CAIA, CIPM, CCRA, CIIB, AIM, CIRA

Quants | Hypothesis Testing

(Assume α= 5% if not mentioned in the question)

1(A). A researcher has gathered data on the daily returns on a portfolio of call options over a recent 200-day
period. The mean daily return has been 0.2%, and the sample standard deviation of daily portfolio returns is
0.50%. The researcher believes that the mean daily portfolio return is not equal to zero.
A. Construct a 95% confidence interval for the population mean daily return over the 200-day sample period.

B. Construct a hypothesis test of the researcher’s belief.

1(B). Perform a z test using the option portfolio data from question 1(A) to test the belief that option returns are
positive.

2. A manufacturer of a car claims that the average life of the car is 6 years. We took a sample of 10 cars which gave
a mean of 5.4 years with an S.D. of 2.2 years. From past experience it is known that SD of all the cars manufactured
by the manufacturers is 2.5 years. Test at 1% significance whether the average life is significantly less than the claim
of 6 years.

3. The average contents in a match box is claimed to be 80. The manufacturer felt that there in overfilling going on.
He therefore took a sample of 5 boxes. He found - 78, 85, 90, 84 & 80. Test at 5% significance, whether the average
contents are significantly greater than 80.

4. A research analyst feels that the average monthly returns on NIFTY has fallen from the past historical average of
1.5%. To test the same, he collected a sample of 2 years and this gave him a mean of 1.4% with S.D. of 0.5%. Test at
5% level of significance whether the average monthly return has fallen.

5. Using option portfolio data from question 1(A), construct a 95% confidence interval for the population mean daily
return over 200- day sample period. Use a z-distribution. Describe if the hypothesis µ=0 should be rejected.

6. When your company’s gizmo machine is working properly, the mean length of gizmos is 2.5 inches. However,
from time to time the machine gets out of alignment and produces gizmos that are either too long or too short.
When this happens, production is stopped and the machine is adjusted. To check the machine, the quality control
department takes a gizmo sample each day. Today, a random sample of 49 gizmos showed a mean length of 2.49
inches. The population standard deviation is known to be 0.021 inches. Using a 5% significance level, determine if
the machine should be shut down and adjusted.

State true or false

1. If a null hypothesis is rejected at 5% significance, it will definitely be rejected at 10% significance.

2. If we fail to reject Ho in one tailed test, we will obviously fail to reject Ho in a two tailed test at the same α.

3. A statistician wrongly used a ‘z’ test instead of a ‘t’ test and he failed to reject Ho. If he now corrects his
mistake and uses ‘t’ test, Ho may or may not be rejected.

1 +91 9830497377
Aswini Bajaj
CFA, FRM, CA, CS, FM, CAIA, CIPM, CCRA, CIIB, AIM, CIRA

Testing of Variance
If the population is normal, we can use the chi square distribution for testing the variance of a population. “Chi
square” distribution is a right skewed distribution with a single parameter.
I.e. degrees of freedom = n – 1. The “chi square” table gives us the values of chi square for area in the right tail.

1. A trader who actively trades on NIFTY options feels that, the monthly volatility of the continuous returns on NIFTY
has significantly changed from the past level of 8%. He collected the month end closing values of NIFTY for the last
year- 10429 10390 10929 10199 10360 10980 10920 10790 10610 10990 10990 10800
Test at 5% level of significance whether volatility has changed from the past level of 8%.

2. Historically, Motilal Oswal has advertised that its monthly returns have a standard deviation equal to 4%. This
was based on estimates from the 2005–2013 period. Motilal Oswal wants to verify whether this claim still
adequately describes the standard deviation of the fund’s returns. Motilal Oswal collected monthly returns for the
24-month period between 2013 and 2015 and measured a standard deviation of monthly returns of 3.8%. High-
Motilal Oswal calculates a test statistic of 20.76. Using a 5% significance level, determine if the more recent
standard deviation is different from the advertised standard deviation.

Testing of Equality of Variance

(Also called analysis of variance, anova)

If there are two normal populations, F distribution can be used to test the equality of variance. F distribution is a
right skewed distribution with 2 parameters.
The F table gives us the value of F for area in the right tail. However only two tail areas are entertain able –5% and
2.5%.

1. We hypothesize, let the SD of the incomes of people in Calcutta is less than that of people in Bombay. We took a
sample from each population which gave the following results.
Size SD
Calcutta 11 6000
Bombay 16 9000

Test at 5% significance whether volatility in Calcutta is significantly lower than that in Bombay.

2. Rachel Green is examining the earnings for two different industries. Rachel suspects that the earnings
of the textile industry are more divergent than those of the paper industry. To confirm this suspicion,
Rachel has looked at a sample of 31 textile manufacturers and a sample of 41 paper companies. She
measured the sample standard deviation of earnings across the textile industry to be $4.30 and that of
the paper industry companies to be $3.80. Rachel calculates a test statistic of 1.2805. Using a 5%
significance level, determine if the earnings of the textile industry have greater standard deviation than those of
the paper industry.

2 +91 9830497377
Aswini Bajaj
CFA, FRM, CA, CS, FM, CAIA, CIPM, CCRA, CIIB, AIM, CIRA

Test of Equality of Mean

Case I: Dependent Sample

1. There is a gym claiming weight reduction of at least 10 kg in one month time. We suspect their claim. α = 5
%. Data collected on 14 persons:

2. Ross Gellar is examining changes in estimated betas for the common stock of companies in the
telecommunications industry before and after deregulation. Gellar believes that the betas may
decline because of deregulation since companies are no longer subject to the uncertainties of rate
regulation or that they may increase because there is more uncertainty regarding competition in the
industry. Gellar calculates a t-statistic of 10.26 for this hypothesis test, based on a sample size of 39.

Using a 5% significance level, determine whether there is a change in betas.

Case II: Independent Samples

3. We have to select 1 out of 2 fund managers A & B. We took sample data on their monthly returns which is given
below:

Manager No Of Months Mean % SD

A 12 2.5 4
B 18 2 3

Test at 5 % significance whether fund manager A is significantly better than fund manager B. Assume that both the
samples are drawn from two different populations with the same variance.

4. Joey Tribbiani is investigating whether the abnormal returns for acquiring firms during merger
announcement periods differ for horizontal and vertical mergers. She estimates the abnormal returns
for a sample of acquiring firms associated with horizontal mergers and a sample of acquiring firms
involved in vertical mergers. Tribbiani finds that abnormal returns from horizontal mergers have a mean
of 1.0% and a standard deviation of 1.0%, while abnormal returns from vertical mergers have a mean
of 2.5% and a standard deviation of 2.0%. Tribbiani assumes that the samples are independent, the population
means are normally distributed, and the population variances are equal. Tribbiani calculates the t-statistic as –
5.474 and the degrees of freedom as 120.
Using a 5% significance level, should Tribbiani reject or fail to reject the null hypothesis that the abnormal returns
to acquiring firms during the announcement period are the same for horizontal and vertical mergers?

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