Financial Econometrics

| March 27, 2015

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Having performed exceptionally well in the last assignment, your manager Mrs. Fama, has asked you to put together another team of between three and four colleagues. The Management Board require further information on Sundia before they introduce a tracker/index portfolio in this stock market and as such require an examination of the volatility of stock returns for Sundia.

In addition, the Management Board also requires an investigation into the co-integration of Sundia in comparison to the key markets that they also offer tracker/index portfolios in. They are, France, Spain, Sweden and Poland.


This information will allow the Management Board to determine the most suitable target customers for the  Sundia tracker/index portfolio.


You are required to prepare a 3,500 word report which will be presented to the Management Board informing them of your findings. Your report should also be accompanied by an Executive Summary which should be no more than 350 words (in addition to the 3,500 words for the report). This will be used by the Management Board in their monthly meeting, so only the key points should be included.


Mrs. Fama has again given you a helping hand and has provided you with the data in order to carry out your examination.




You and your team are required to;


PART ONE:In the first part, you are required to estimate the following models for the 100 stocks from the Sundia stock market:

  1. Please fit the ARCH(q) model for all 100 stocks listed in Sundia. Comment on your choice of order q.
  2. Explain the limitations of ARCH(q) and instead fit the GARCH(1,1) model. Discuss briefly the advantages of the latter.
  3. Discuss how GARCH(1,1) may not be reflective of the leverage effect for the stocks. How can this be remedied? Describe the functional form of GJR GARCH and EGARCH. Estimate both specifications for 100 stocks. Do you observe a significant leverage effects for these stocks? Explain.
  4. It is sometimes argued that higher volatility will be reflected in stock returns demanded by investors. In that context, describe the GARCH-M model and fit it for all Sundia stocks. Is the volatility term in the returns equation significant? Discuss.


PART TWO: You need to perform co-integration testing on France, Spain, Sweden and Poland ascountry pairs. You will need to obtain the historical prices for these stock markets using Datastream.You will need to compare France with Sundia, Spain with Sundia, Sweden with Sundia and then finally Poland with Sundia. Please comment on your results for each of the co-integration tests in the light of the following issues:

  1. Is cointegration found for this pair of series of returns?
  2. What is the order of cointegration?
  3. Based on your knowledge of Finance and Economics, are the results in accordance with intuition?
  1. Write a 3,500 report with your findings – this should be aimed at those members of the Management Board that have substantial knowledge of the Econometric content.
  2. Write a 350 word Executive Summary that includes the key points/findings of the main report. This will be used in the Management Board meeting so must be to the point.
  3. In line with company policy, you are required to record the minutes of three team meetings to allow the contribution of each team member to be assessed.


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