2019/2020 Sem I Financial Econometrics

Pre-requisite: Passed Basic Econometrics and Statistics II

You do not have to print these slides.
It will be available in Spectrum

1
What does the course offer?

Read the Proforma and current course information

This course offers you some new techniques in econometrics which are useful if you intend
to estimate model using financial data

This course is also known as Econometrics of financial time series

There are specialized models used in finance such as CAPM, APT and many more.

It is a cumulative work of many scholars and practitioners since 1950s.

Today, there is a branch known as Financial Economics (it is a wider concept)

2
What is financial data?

3
What are the features of financial data?
 Random or stochastic in nature (Financial series is non-stationary)
 The distribution of series is not normal (leptokurtic or fat-tailed distribution)
 The series exhibits volatility clustering (It has ARCH effect)
 Shock➔ bad news ➔ Black Swan event
https://www.investopedia.com/articles/trading/11/black-swan-events-
investing.asp

Data visualization (Step 1 in Data Science)

Plot the series.
What is the direction? Up or down?
Convergent or Divergent?
Is there trend, cycle, seasonality in the series (macroeconomic variables)?
Modelling the series or a group of series (Step 2)
Econometrics 101 or Financial Econometrics 501 4
Is there a relationship between stock
price and crude oil?

5
https://www.freemalaysiatoday.com/category/business/2019/09/12/bank-negara-expected-to-hold-
key-interest-rate/

6
Economic Modelling versus Forecasting

 Economic Modelling is to find the causal relationship between the variables.

 Forecasting is not trying to understand the causal relationship, but

forecasting the future value of a series. (please also attend Time Series
Analysis)

 In this course, we will use multivariate model to study the dynamic

relationship between the variables.

 Dynamic relationship refers to the linkages between variables over a period of

time. This could be short-run or long-run relationship

7
What are the topics?

 1. The concept of Price and Return

 2. Stock Indices (Method of averaging / Changes in capital)
 3. Stock exchanges
 4. Efficient Market Hypothesis (refers to informational efficiency)
 5. Stationarity of data (unit root test)
 6. VAR model (short-run model)
 7. VECM (Error-correction model)
 8. TYDL (Augmented VAR model ➔ long-run model)
 9. Asset Pricing Model (alpha and beta in CAPM, APT, Fama-French Three
Factor, Equity Style Model) small topic on calendar effect or anomalies
 10. Volatility Model (ARCH, GARCH, GARCH-M)
8
Will the course be useful to you?
 If you intend to conduct econometric analysis on financial data
(not ratio analysis like current ratio)
 If you want to be an Economist
 If you intend to work in Central Bank, Think Tank, Research houses, investment banks, etc.
 If you intend to understand financial markets (it is a complicated world)
 If you need to write a thesis for graduation

 The Key Issues:

 Do you know the right variables to use?
 Do you know how to retrieve the data from the source?
 Can you estimate correctly the given data? What models to use?
 Can you interpret the results from software output?
 Can you convince your readers with your written report?
9
Learn your trade well; Refine your skills

 Some people estimate the model wrongly

(They did not learn their trade well)
(Good excuse: it is a complicated subject)

 Know your models well (different models for different type of data)

 Understand the concept of long-run and short-run models

 Read the recent literature when you are planning to start a research
(what models and what kind of data are often used?)

 Get the data and estimate the model

(you will never know the empirical results until you run it)
10
Brief format of research proposal
 Proposed Title: xx
 Area of Research: xx (For example ➔ Applied Finance / Macroeconomics)


 1. Introduction
 2. Problem Statement / Motivation
 Research Questions
 Research Objectives
 3. Literature Review
Conceptual /Theory Framework (Eg: Taylor Rule; Solow-Swan Growth Model)
 Hypothesis Development
 4. Data and Methodology
 5. Significance of the Study
 References 11
Models

 Y = f (X1, X2, X3, X4, X5) ➔ Mathematical Model (Step 1)

 Hypothesis (a proiri)
 https://www.economicshelp.org/blog/glossary/apriori/#targetText=Definition%2
0a%20priori%3A%20An%20a,that%20firms%20are%20profit%20maximisers.
 https://mises.org/library/what-priori-science-and-why-does-economics-qualify-
one

 From mathematical model ➔ expand to regression model

 Regression Model ➔ causal effect (Step 2)
 Correlation (very basic ➔ just show association ➔ Not causal effect)
12
Taylor Rule
 https://en.wikipedia.org/wiki/Taylor_rule#targetText=In%20economics%2C%2
0a%20Taylor%20rule,output%2C%20or%20other%20economic%20conditions.&tar
getText=This%20aspect%20of%20the%20rule%20is%20often%20called%20the%20
Taylor%20principle.

 Technology Acceptance Model (TAM)

 https://en.wikipedia.org/wiki/Technology_acceptance_model#targetText=Th
e%20technology%20acceptance%20model%20(TAM,accept%20and%20use%20a%2
0technology.&targetText=Perceived%20ease%2Dof%2Duse%20(,effort%22%20(Da
vis%201989).

13
Literature Review

 Google scholar (search with keywords)

 www.nber.org
 www.ssrn.com
 Jstor
 Google search
 Published papers in Journals ➔ SSCI-indexed or Scopus-indexed journals
 MyCite
 Working paper series

 What are you reviewing ➔ read abstract, read the results,

 variables, model, data, the findings

14
Assignment and Test
 Mid-term test (20%) ➔ To be conducted only once. No absence.
 ➔ Lab test (5% is included)
 ➔ End of October or early Nov

 Assignment 1 and 2 (5% each) – Group assignment

 Assignment 3 is writing research proposal (10%) Individual assignment

 Due on 5 December

 Choose a topic you are interested and know slightly more than others
 Which segment of financial markets are you interested to look into?
 Banking / Exchange Rate / Stock Prices / Bond market / SUKUK/ REIT / ETFs /
Macroeconomic variables / Spot and Futures market

15
Lecture Plan
 Lecture notes ➔ Hard facts / Concept / Equations / Models / Data

 Learning Strategies in class:

 Quiz ➔ Everyone has the chance to answer (to check your understanding)
 Lecture, followed by Eviews hands on with data

 Tutorials
 Tutorial questions will be used to check hard facts (Please do your self-learning)
 Tutorials, start from week 3

 Student-learning time:
 Case studies and practice questions (some exercises will be asked to be submit after e-
learning week)
 Revise on your own / assignment / mid-term test
 Final exam covers all topics

16
Logistics
 Lecture Hours Thursday 11am to 1pm (Lab G2/G3)
 Tutorial Class: Wednesday 5pm to 6pm (Lab Utiliti, Ground Floor)

 More detailed plan with date will be given

 No class for 2 week➔ 7 to 19 October 2019 (You will need to submit HW)

 E-learning week (You will be asked to submit HW)

 For WEEK 8 OF SEMESTER 1 2019/2020, Date : 28 October to 2 November 2019

 For every assignment or HW, indicate 3 things:

your name (no. in the class namelist), matric no.

17