Module Title

Financial Econometrics

Assignment

Number

1

Module Code

ACFI3308

Assignment

Title

Report

Module Leader

Dr Freddie Ahiabor

Assignment

Weighting

40%

Assignment Release Date:

6th July 2023

Submission

Date/Time:

15 August 2023 at 12noon

Assessment Information – What you need to do

This assignment is an individual assignment.

You are the equity analyst for F&H Capital, a global investment firm located in New York. Your main task is to track the US and global equity markets and make recommendations to the trading departments. On this specific occasion, you are asked to provide an “Equity Research Report” on a portfolio of equities and and mutual funds.

There  are  two  asset  pricing  models  that  the  firm  uses  in assessing  the  predictability of  the securities. These models are the Capital Asset Pricing Model (CAPM) and the Fama-French Three-

Factor model.

The empirical CAPM is specified as follows:

Rxt = a + β1 Rmt (1)

where:

β1 is the market beta of portfolio X; a is the intercept term.

Rxt = (Rct − Rft) defines the excess return on the portfolio X at time t

Rmt = ( Rmkt − Rft) defines the market premium (return on the market portfolio - S&P 500

index) at time t.

Rct, Rmkt and Rft are the return on portfolio c, market index mk and the risk rate, respectively.

The empirical Fama-French Three-Factor model is specified as follows:

Rxt = a + β1 Rmt +   β2SMBt + β3 HMLt (2)

where:

SMBt = Excess return of small cap over high cap firms at time t

HMLt =Excess return of value stock over growth stock at time t

The details of your report are itemized below.

SECURITY SELECTION AND PORTFOLIO CONSTRUCTION

1.  FromYahoo Fund Screener, select ten (10) securities from the following class of assets.

. Three (5) equities listed on the NYSE or NASDAQ

. Four (5) mutual funds domiciled in the US

2. For each security, download the daily adjusted close price series from 1 January 2005 to 31

December 2022.

3. Transform the daily price series to the monthly price series for each fund in your portfolio.

4. Transform the monthly price series to return series.

5. Construct a portfolio with the ten securities you picked using the following weights.

. Equities – 50%

. Mutual Funds – 50%

[Hint: This is equivalent to setting the weight of each security to 10%]

6. Set the rebalancing of your portfolio to one (1) year.

TIME SERIES VISUALISATION

7. Plot the monthly price series of your portfolio

8. Discuss the patterns you observe in the price and monthly series. The discussion should use

relevant underpinning theories and economic events that explains the pattern observed.

ASSET PRICING REGRESSION

From theFama-French websitedownload directly into R the monthly Fama-French-Three factor

return series.

Restricting the observations to the period 1 January 2005 to 31 December 2018;

9. Estimate a CAPM regression using equation (1) above and interpret your coefficients.

10.    Estimate a Fama-French Three-Factor regression using equation (2) above and interpret

your coefficients.

11.    Compare the results of the two pricing models and discuss any similarities and differences.

(Comment on the R-Squared and F-Statistics).

12. Test for serial correlation (autocorrelation) and heteroskedasticity in your CAPM and Fama-

French Three factor models.

FORECASTING

13.   Compute the root mean square error (RMSE) and mean absolute percentage error (MAPE)

for the two asset pricing models and comment on the accuracy of your forecasts.

14.   Assess  how well the two  asset  pricing  models  perform in  predicting the  portfolio  return

between 1 July 2018 to 30 Decmber 2022.