Eric Zivot Econ 424 Winter 2015 Problem Set #4 Descriptive Statistics and the Constant Expected Return Model Due: Tuesday 2/3/15 at 8 pm via Canvas. Readings My class slides on descriptive statistics and lecture notes on the constant expected return model Ruppert chapter 4 (Exploratory data analysis) “Working with Time Series in R" on class syllabus page (see Additional Material column for weeks 2-3) PerformanceAnalytics and zoo vignettes (see R Hints page on class webpage under Packages) Introduction to the corrplot package: http://cran.rproject.org/web/packages/corrplot/vignettes/corrplot-intro.html Programs and Data Econ424lab4.r descriptiveStatistics.r cerModelExamples.r R script file hints for lab R script file used for class examples R script file used for class examples Instructions In this lab you will use R to Compute univariate, bivariate and time series descriptive statistics Estimate parameters of the constant expected return (CER) model, compute standard errors and confidence intervals Exercises The following questions require R. On the class web page are the script files econ424lab4.r, descriptiveStatistics.r and cerModelExamples.r. The former contains hints for completing the assignment, and the latter files contains the code for the doing the examples from class. As in lab 3, copy and paste all statistical results and graphs into a MS Word document while you work, and add any comments and answer all questions in this document. Please do not turn in the assignment without comments! In this lab, you will analyze continuously compounded monthly return data on the Vanguard long term bond index fund (VBLTX), Fidelity Magellan stock mutual fund (FMAGX), and Starbucks stock (SBUX). I encourage you to go to finance.yahoo.com and research these assets. The script file econ424lab4.r walks you through all of the computations for the lab. You do not need to show the R commands in your lab write up. You will use the get.hist.quote() function from the tseries package to automatically load this data into R. You will also use several functions from the PerformanceAnalytics package. Remember to install packages before you load them into R. Part I: Descriptive Statistics I. Univariate Graphical Analysis 1) Make time plots of the return data using the R command plot()as illustrated in the script file econ424lab4.r. Comment on any relationships between the returns suggested by the plots. Pay particular attention to the behavior of returns toward the end of 2008 at the beginning of the financial crisis. 2) Make a cumulative return plot (future of $1 invested in each asset) and comment. Which assets gave the best and worst future values over the investment horizon? 3) For each return series, make a four panel plot containing a histogram, density plot, boxplot and normal QQ-plot. Do the return series look normally distributed? Briefly compare the return distributions. II. Univariate Numerical Summary Statistics 1) Compute numerical descriptive statistics for all assets using the R functions summary(), mean(), var(), stdev(), skewness() (in package PerformanceAnalytics) and kurtosis() (in package PerformanceAnalytics). Compare and contrast the descriptive statistics for the three assets. Which asset appears to be the riskiest asset? 2) Using the mean monthly return for each asset, compute an estimate of the annual continuously compounded return (i.e., recall the relationship between the expected monthly cc return and the expected annual cc return). Convert this annual continuously compounded return into a simple annual return. Are there any surprises? 3) Using the estimate of the monthly return standard deviation for each asset, compute an estimate of the annual return standard deviation. Briefly comment on the magnitude of the annual standard deviations. III. Historical VaR 1) For each asset compute the empirical 1% and 5% quantiles of the cc returns. Using these quantiles compute the 1% and 5% historical (monthly) VaR values based on an initial $100,000 investment. Which asset has the highest and lowest VaR values? Are you surprised? III. Bivariate Graphical Analysis 1) Use the R pairs() function to create all pair-wise scatterplots of returns Comment on the direction and strength of the linear relationships in these plots. 2) Use the functions corrplot() and corrplot.mixed() in the R package corrplot, plot the correlation matrix of the returns on the three assets. IV. Bivariate Numerical Summary Statistics Use the R functions var(), cov(), and cor() to compute the sample covariance matrix and sample correlation matrix of the returns. Comment on the direction and strength of the linear relationships suggested by the values of the covariances and correlations. V. Time Series Summary Statistics Use the R function acf() to compute and plot the sample autocorrelation functions of each return. Do the returns appear to be uncorrelated over time? Part II: Constant Expected Return Model Consider the constant expected return model (CER) Rit i it , t 1, , T it ~ iid N (0, i2 ) cov( it , jt ) ij where Rit denotes the continuously compounded return on asset i, i =Vanguard long term bond index fund (VBLTX), Fidelity Magellan stock mutual fund (FMAGX), and Starbucks stock (SBUX). a) Using sample descriptive statistics, give estimates for the model parameters i , i2 , i , ij and ij . Arrange these estimates nicely in a table. Briefly comment. Hint: you already computed these estimates in Part I. Just put them in a table. b) For each estimate of the above parameters (except ij) compute the estimated standard error. That is, compute SE ( ˆ i ), SE (ˆ i2 ), SE (ˆ i ) and SE ( ˆij ). Briefly comment on the precision of the estimates. Hint: the formulas for these standard errors were given in class, and are given in the lecture notes on the constant expected return model c) For each parameter i , i2 , i , and ij compute 95% and 99% confidence intervals. Briefly comment on the width of these intervals. d) Using the estimated values of i , i2 for each mutual fund, compute the normal distribution 1% and 5% monthly value-at-Risk (VaR) based on an initial $100,000 investment. Compare these values with the historical VaR values computed earlier. Ruppert, Chapter 4, Section 11 (R lab) Do problems 1, 2 and 3 (skip discussion of Shapiro-Wilks statistic).

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