Economics

1

You have been allocated monthly time-series data for the United States over the period January 1980-December 2009. The data refer to the following variables:

S :the nominal stock price of a given company;

FED :the nominal short-term interest rate, measured by the effective federal funds ratea (yields in percentage per annum);

IP :the level of industrial production.

Let NSRt be the monthly stock returns of the assigned company. Consider the following regression model:

NSRt = β1 + β2 · FEDt + ut, (1)

where FEDt is assumed to be a stationary series.

1. Report the time series plots of the series and the scatter plot. Comment on the graphs. [10%]

2. Use Ordinary Least Squares (OLS) to estimate the regression model (1). Report and discuss your results with reference to the Present Value

Theory, also known as Discounted Cash Flow Modelb . [20%]

3. Plot the actual values, the fitted values and the residuals and comment on the model fitting. [10%]

4. Analyze the regression output applying the appropriate diagnostic tools. Will your answer for question 2 remain the same when potential diagnostic problems are taken into account? [15%]

5. The most intense period of the recent financial crisis lasted between September 2007 and March 2009. Test whether the relationship between stock returns and interest rate has been affected by the financial crisis, i.e. if the relationship before and during the crisis can be considered statistically different. [15%]

a For more information please see https://research.stlouisfed.org/fred2/series/ FEDFUNDS

b See C. Ioannidis and A. Kontonikas (2008) The impact of monetary policy on stock

prices, Journal of Policy Modelling 30, 33-53.