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BE333 Empirical Finance

Question 1

a. Describe the five (5) steps involved in running an Ordinary Least Squares (OLS) regression from the initial point of deciding the theoretical model to stating the conclusions on the results

b. A researcher obtained the following OLS estimates for a UK firm’s stock price using 120 monthly observations from 1980 to 1989 (All variables in logarithms):

Ist is the log of the stock price, pt is the log of profits, yt is the log of its output in the UK, rt is the log of expenditure on research and development and mt is the log of expenditure on Marketing. Figures in parentheses are standard errors and RSS is the Residual Sum of Squares.

i. Briefly evaluate the reasons behind including the above explanatory variables in the regression.

ii. What is the explanatory power of the regression?

iii. Individually using the t-test, test whether each coefficient equals 0, at the 5% level of significance
iv. Using a t-test, does the coefficient on the variable lnyt = 1? 

Question 2
A.Assume that the econometric model is of the form: 
Which of the following hypotheses about the coefficients can be tested using a t -test? Which of them can be tested using an F-test? In each case, state the number of restrictions. 

i. What pattern(s) would one like to see in a residual plot and why?
ii. If the residual plot shows a pattern, for example a cyclical pattern, what does this mean for the model?

C. What five assumptions are usually made about the unobservable error terms in the classical linear regression model (CLRM)? Briefly explain the meaning of each. Why are these assumptions made?  

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