HARARE INSTITUTE OF TECHNOLOGY

SCHOOL OF BUSINESS AND MANAGEMENT SCIENCES

DEPARTMENT OF FINANCIAL ENGINEERING

B. TECH DEGREE IN FINANCIAL ENGINEERING

BFE 2111: FINANCIAL ECONOMETRICS I

TIME: 3 HOURS DATE: NOV/DEC 2020

INSTRUCTIONS TO CANDIDATES:

 The paper has six (6) questions

 Choose any four (4) questions
 Each question carries 25 marks
 The artificial and natural persons in this paper are intended to be fictitious

ADDITIONAL MATERIALS

 Statistical tables

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Question One

a) One application of econometric techniques is in the area of hedonic pricing

models. The table below shows an extract of a research done in Mutare,
which considers factors that influence rental values for buildings.

Table 1: Results of research done in Mutare

Variable Coefficient t-ratio Expected sign

Intercept 282.21 56.09 +

LnAGE -53.10 -59.71 _

NBROOMS 48.47 104.81 +

AREABYRM 3.97 29.99 +

ELEVATOR 88.51 45.04 +

BASEMENT -15.90 -11.32 _

OUTPARK 7.17 7.07 +

INDPARK 73.76 31.25 +

NOLEASE -16.99 -7.62 _

LnDISTCBD 5.84 4.60 _

SINGLPAR -4.27 -38.88 _

DSHOPCNTR -10.04 -5.97 _

VACDIFF1 0.29 5.98 _

Note: Adjusted R-squared = 0.651; regression F-statistic = 2082.27

Where,
LnAGE log of the apparent age of the property
NBROOMS number of bedrooms
AREABYRM area per room (in square metres)
ELEVATOR a dummy variable = 1 if the building has an elevator; 0 otherwise

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BASEMENT a dummy variable = 1 if the unit is located in a basement; 0
otherwise
OUTPARK number of outdoor parking spaces
INDPARK number of indoor parking spaces
NOLEASE a dummy variable = 1 if the unit has no lease attached to it; 0
otherwise
LnDISTCBD log of the distance in kilometres to the central business district
(CBD)
SINGLPAR percentage of single parent families in the area where the
building stands
DSHOPCNTR distance in kilometres to the nearest shopping centre
VACDIFF1 vacancy difference between the building and the census figure

Discuss the results above [20]

b) A fellow financial engineering student suspects that the residuals of her model
might be autocorrelated. Explain the steps involved in testing this theory using
the Durbin–Watson (DW) test. [5]

Question Two

a) Fig. 1 below shows the relationship between Sunberry (Pvt) Ltd share price
(Y) and size of the firm (X) in the form of a scatter diagram.

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 Fig 1.

i) On a separate sheet of paper superimpose a line that most likely

generalises the relationship between the two variables. [2]

ii) Label each of the observations (a) to (g) and make reference to your
diagram to illustrate how the Residual Sum of Squares (RSS) can be
obtained. [10]

b) Given that the relationship between the share price and size of the firm in (a)
above can be generalised by a linear function of the form SPt    SFt   t ,

derive the general expressions for the values of  and  . [10]

c) Table 2: Share Price and Size of the Firm data.

Y X
108.4 6,858
109.2 6,689
110 6,777
110.3 6,342
121.5 5,727
129.7 5,805
135.1 5,755
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 Given the above set of data and the expressions you obtained in (b),
determine the estimates of  and  . [3]

Question Three

a) Given the assumptions in column 1 of the table, show that the assumptions in
column 2 are equivalent to them.

Column 1 Column 2

(i) E(u i \ X i )=0 E(Y i |X i ) = β 2 + β 2 X [5]

(ii) cov (u i ,u j ) = 0 i j cov (Y i , Y j ) = 0 i j [5]

(iii) var (u i |X i ) = σ 2 var (Y i |X i ) = σ 2 [5]

b) A researcher estimates the following two econometric models:

Y t = β 1 +β 2 X 2 t +β 3 X 3t +u t

Y t = β 1 +β 2 X 2 t +β 3 X 3t β 4 X 4 t +v t ,

where u t and v t are iid disturbances and X 3t is an irrelevant variable which

does not enter into the data generating process for Y t .

Explain whether the value will be higher for the second model than the first for
i) R-squared [3]
ii) Adjusted R-squared [3]
c) Illustrate the difference between cross section and time series data. [4]

Question Four

a) As a financial econometrician, you obtain the following sample

autocorrelations and partial autocorrelations for a sample of 100 observations
from actual data:

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 Lag 1 2 3 4 5 6 7 8
acf 0.420 0.104 0.032 -0.206 -0.138 0.042 -0.018 0.074
pacf 0.632 0.381 0.268 0.199 0.205 0.101 0.096 0.082

i. Identify the most appropriate time series process for this data. [2]
ii. Use the Ljung–Box Q test to determine whether the first three autocorrelation
coefficients taken together are jointly significantly different from zero. [5]
b) With the aid of technical notations, explain the following time series concepts:

i. Strictly stationary process [3]

ii. Weakly stationary process [3]
iii. White noise process [3]
c) The following results in Fig 2 below were obtained when the researcher
wanted to test stability of his model:

Fig 2.

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 Comment on the stability of the dependent variable from the results shown
above. [4]

d) Show that AR (q) process can be represented as an MA (  ) process. [5]

Question Five

a) A financial econometrician modelling bond returns using univariate time series

modelling techniques obtained the following values of the Hannan Quin
Information Criteria (HQIC) for models in the range ARMA(0,0) to ARMA (3,3):

p/q 0 1 2 3
0 2.034 3.111 2.005 3.222
1 3.001 2.956 2.001 2.865
2 2.955 3.100 2.111 2.650
3 3.222 3.004 2.102 2.444

Denote bond returns by BR and write the parsimonious ARMA model for BR
that is based on the determination of the HQIC above. [4]

b) With the aid of technical notations for any two dynamic econometric models,
distinguish between distributed lag and autoregressive distributed lag models.
[5]

c) In each of the models below, show how it is possible to apply ordinary least
squares estimation method.


i. Yt  AX t e ut [3]


ii. Yt     ut [3]
Xt

d) Distinguish between Type I and Type II errors in hypothesis testing. [5]

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 e) Justify the significance of a stochastic disturbance term in a regression model.
[5]

Question Six

a) With the aid of any four examples explain in detail the usefulness of financial
econometrics. [8]

b) With the aid of technical notations, explain the five assumptions that are made
about the unobservable error terms in the Classical Normal Linear Regression
Model (CNLRM). [10]
c) Use the standardised third and fourth moments of a distribution to
diagrammatically illustrate the distinction between a mesokurtic, leptokurtic
and platykurtic distributions. [6]
d) Explain the term regression analysis. [1]

THE END

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