Empirical Project: Testing Validity of CAPM and Phillips Curve Relationship

Description of Assessment Task and Purpose

Description of Assessment Task and Purpose: The coursework of this module consists of an individual project. The required word count is 3,000 words in total excluding tables, graphs, and appendices.

Please note that this is an individual empirical project. You should work independently. Collaboration is considered dishonest and unprofessional. Please see module handbook on “Dishonesty and Plagiarism” and related University Regulations.

LO1 Assess the properties of time series data using such operations as autocorrelation functions, unit root tests, and tests for cointegration

LO2 Compile a suitable model using time series data and evaluate its lag structure using model selection criteria

LO3 Implement and interpret critically the outputs from econometric software packages

LO4 Critically assess the implications of econometric models in the time series literature.

Knowledge and Skills Assessed:

• Apply statistical and mathematical skills to test the validity of economic theories.

• Collect and transform time series data for empirical analysis.

• Implement time series methodologies appropriately and solve possible econometric problems arising from the results using a software such as Eviews.

• Understand, interpret and discuss the results obtained from estimations.

Answer All the Following Questions

Note that this is not an essay type assignment. Please simply answer the questions below one by one.

1. This exercise is based on testing the validity of the Capital Asset Price Model (CAPM) for 2000-2019 period. Download monthly a time series stock price data. Let’s call it X. For the case of UK stock market, for example, one can easily download stock price data from the Yahoo Finance UK website (https://uk.finance.com/) or DataStream. Download monthly data for the stock market portfolio proxy. Let’s call it M. For the case of UK stock market, it is the

FTSE-100 index. Assume that all stocks are risk free for simplicity.

(i)Calculate percentage returns of stock, (RX) and percentage returns of the FTSE-index, (RM) as follows, respectively:

(ii)Implement unit-root tests on the variables of RX and RM and evaluate your results.

(iii)Estimate following regression equation: RXt=α + βRMt +εt by OLS and test the residuals for serial correlation, heteroscedasticity, normality, and unit-roots and evaluate your results.

(iv) If possible, eliminate econometric problems such as serial correlations by implementing appropriate econometric techniques, re-estimate the regression equation and interpret your results.

2. This exercise is based on testing the validity of Phillips curve relationship. Download data from DataStream or FRED (Federal Reserve Bank of St Louis) the following quarterly variables for a country from 1950 to 2020 (or as however long the sample period is available in the data bases).

Quarterly values of inflation rates, seasonally adjusted.

Quarterly values of unemployment rates, seasonally adjusted.

(i) Establish the order of variables by implementing appropriate unit root-tests, present them appropriately on a summary table, and evaluate your results. (Hint: you may use more than one unit-root tests).

(ii)Implement Granger-causality analysis for both variables, summarize your results on a table appropriately, and interpret your results.

(iii)Implement impulse response analysis for both variables, summarize your results on a table appropriately, and interpret your results.

(iv)Implement Johansen cointegration test and interpret your results.

(v) Implement vector error-correction model (VECM) and interpret your results.

Important Information on Dishonesty & Plagiarism:

University of Lincoln Regulations define plagiarism as 'the passing off of another person's thoughts, ideas, writings or images as one's own...Examples of plagiarism include the unacknowledged use of another person's material whether in original or summary form.Plagiarism also includes the copying of another student's work'.

Plagiarism is a serious offence and is treated by the University as a form of academic dishonesty. Students are directed to the University Regulations for details of the procedures and penalties involved.