Individual Assignment 1 Quantitative Application in Finance

Submitted to Dr. Alok Dixit

Submitted by Atul karwasara

Date July 25, 2016

PGP ID PGP31143

1. Data Information

High frequency 5 minute data from July 1, 2015 to June 30, 2016 (1 year data).
No. of observations in sample is 18525.
Data heads and interpretation o Time interval Represents 5 minute time interval for particular day for which
price movements are observed
o Close - Closing price of the stock at the end of time interval
o Open - Opening price of the stock at the start of time interval
o Net chg Algebraic change in price in particular interval measured as
Net chg = Close - open
o High - Highest price of the stock during 5 minute time interval
o Low Lowest price of the stock during 5 minute time interval
o Volume Number of shares traded during the period

2. Logarithmic returns
Logarithmic retunes are calculated as below 2 formula because for 5 minutes high frequency
data Opening price for any period is very close ( many time equals) to closing price of
immediate previous period, i.e.

Open(t) = Close(t 1)

Logarithmic returns for period = (

). (1)

Logarithmic returns for period = () . (2)

Logarithmic returns are calculated using 2nd formula in csv file under header Logarithmic
returns

3. Normality test
Step 1 Import file into tcs and attach tcs for easy column handling in R
#reading CSV file
tcs=read.csv(file.choose(), sep = ",")
#attaching imported file
attach(tcs)

Step 2 Load Package moments, tseries

Step 3 Testing Skewness and kurtosis using below functions
#calculating Skewness
skewness(Logarithmic.returns)
[1] 0.2380699
#calculating Kurtosis
kurtosis(Logarithmic.returns)
[1] 34.6311
#testing Skewness by agostino test
agostino.test(Logarithmic.returns)
D'Agostino skewness test
data: Logarithmic.returns
skew = 0.23807, z = 13.05300,
p-value < 2.2e-16
alternative hypothesis: data have a skewness
#testing Kurtosis by anscombe test
anscombe.test(Logarithmic.returns)
Anscombe-Glynn kurtosis test
data: Logarithmic.returns
kurt = 34.631, z = 73.133,
p-value < 2.2e-16
alternative hypothesis: kurtosis is not equal to 3

Interpretation

Skewness of Logarithmic retunes of TCS has +ve skewness of 0.238 which means that in
TCS logarithmic returns probability of occurring high +ve returns is more than
probability of occurring high ve returns.
From Agostino test we are able to reject H0 : Skewness = 0 and conclude that TCS
logarithmic returns has +ve skewness.
From Anscombe test we are able to reject H0 : Kurtosis = 3 and conclude that TCS
logarithmic returns has excess kurtosis i.e. kurtosis is greater than 3.

As kurtosis is very high comparing to normal distribution which implies that TCS
logarithmic returns has more value near to mean value comparing to a normal
distribution.
#testing normality
jarque.bera.test(Logarithmic.returns)
Jarque Bera Test
data: Logarithmic.returns
X-squared = 772460, df = 2,
p-value < 2.2e-16

Interpretation

Jqrque-bera test has p-value far less than 0.05 and it implies that H0 : excess kurtosis = 0
and skewness = 0 is rejected and we conclude that logarithmic returns of TCS not follow
Normal distribution.

Step 4 Plotting density functions

Density plot of the returns and superimposed density plot of a normal distribution with the
same mean and the same standard deviation is below
#plotting density function of TCS Logarithmic returns
tcs_density_plot<- density(Logarithmic.returns)
plot(tcs_density_plot)
#generating normal distribution with same mean and standard deviation
as that of TCS Logarithmic returns
normal<- rnorm(18525,mean(Logarithmic.returns),sd(Logarithmic.returns))
#generating density function for normal distribution
normal_plot<- density(normal)
#superimposing normal distribution density function over actual plot
lines(normal_plot,col="red")

Interpretation

Black color plot shows actual density plot of TCS Logarithmic returns while red color plot
shows the density plot of a normal distribution with same mean and Standard Deviation
as that of TCS Logarithmic returns. Here it is visible that returns has very high kurtosis
comparing to normal returns and +ve skewness.

4. Volume-cum-returns-based technical indicator

Volret (Volume cum return) is calculated in the csv file under header volret using below
formula

= (
) (
)
1
1

Assumption - Due to unavailability of volume(t-1) for 1st observation (July 1, 2015, 9:15-9:20
A.M.) its value is assumed to be same that of 2nd observation.

5.

Testing stationarity

Step 1 Plotting close price and logarithmic returns to check stationarity by looking at graphical
properties.
# Changing plotting symbol for better visibility
par(pch = ".")

#plotting the closing price

plot(Close)
#plotting the Logarithmic returns
plot(Logarithmic.returns)

Interpretation

It is clearly visible from the above plots that share price (close price here) is not
following the stationary time series as expected while logarithmic returns are following
stationary time series.

Step 2 Plotting ACF, PACF

#plotting the ACF of closing price
acf(Close)

#plotting the PACF of closing price

pacf(Close)

#plotting the ACF of Logarithmic returns

acf(Logarithmic.returns)
#plotting the ACF of Logarithmic returns
pacf(Logarithmic.returns)

Interpretation

ACF plot in the share close price shows declining ACF spikes as autocorrelation is
decreasing (very less per lag) with increasing lag but still it show significant

autocorrelation with higher lags, while PACF has unit root at value 1 which shows the
non stationarity time series of the share price.
ACF plot of Logarithmic returns shows sinusoidal decline in ACF and PACF plot has no
unit root and it shows stationarity of the time series as expected.

Step 3 Testing using ADF (Augmented Dickey-Fuller) test

#adf test on closing share price
adf.test(Close)
Augmented Dickey-Fuller Test
data: Close
Dickey-Fuller = -2.0163, Lag
order = 26, p-value = 0.5715
alternative hypothesis: stationary
#adf test on Logarithmic returns
adf.test(Logarithmic.returns)
Augmented Dickey-Fuller Test
data: Logarithmic.returns
Dickey-Fuller = -26.674, Lag
order = 26, p-value = 0.01
alternative hypothesis: stationary

Interpretation

As expected in the case of share price H0 : time series is non- stationary is not rejected
due to very high p-value = 0.5715 which implies that time series is not stationary.
While in case of Logarithmic returns H0 : time series is non- stationary is rejected due
to p-value = 0.01 which is less than 0.05 which implies that time series is stationary.

6. Determining regression model

Step 1 Looking from the ACF plot we can comment that logarithmic returns are following
moving average MA(2) model due to 2 spikes in ACF.
Step 2 Checking model from auto.arima function
#install package "forecast"
# Determining time series model using auto arima while restricting differencing to
"zero"
auto.arima(Logarithmic.returns,d=0)
Series: Logarithmic.returns

ARIMA(0,0,3) with zero mean

Coefficients:
ma1
-0.0445
s.e.
0.0073

ma2
0.0298
0.0073

ma3
0.0107
0.0074

sigma^2 estimated as 2.055e-06:

AICc=-190010
BIC=-189978.6

log likelihood=95008.98

AIC=-190010

Interpretation

As expected from the ACF graph auto.arima also providing the process to follow MA(3)
but for ma3 test statistics is low (comparing to t-value 1.96 at 5% level of significance)
and it will have very low significance.
= + 0.04451 + 0.02982 + 0.01073

Step 3 ARMAX - Checking significance of volret contemporaneously

#fitting ARMAX regression model with volret contemporaneously
arima_volret <- arima(Logarithmic.returns,c(0,0,3),xreg = volret)
arima_volret
Call:
arima(x = Logarithmic.returns, order = c(0, 0, 3), xreg = volret)
Coefficients:
ma1
-0.0612
s.e.
0.0073

ma2
0.0183
0.0073

ma3
0.0083
0.0074

sigma^2 estimated as 1.753e-06:

aic = -192947.2

intercept
0
0

volret
0.4127
0.0073

log likelihood = 96479.62,

Interpretation

From the aic value it is observed that it is decreased from -190010 to -192947.2 which
implies that returns of TCS are explained by volume-cum-returns and its coefficient is
significant.
= + 0.06121 + 0.01832 + 0.00833 + 0.4127

Preforming LR testTaking model with volret as unconstrained and without volret as constrained model
= = 2(
) ~ 2(1)
LR ratio = [2*(96479.62-95008.98) = 2941] >> [2(1) = 3.841]

Thus H0: volret is not significant is rejected. We can conclude that volret is significantly
explains variations in returns.

#fitting ARMAX regression model with volret lag

arima_volret_lag<- arima(Logarithmic.returns[2:18525],c(0,0,3),xreg = l
ag(volret[1:18524], 1))
arima_volret_lag
Call:
arima(x = Logarithmic.returns[2:18525], order = c(0, 0, 3), xreg = lag(
volret[1:18524],
1))
Coefficients:
ma1
-0.0297
s.e.
0.0079

ma2
0.0325
0.0073

ma3
0.0120
0.0074

sigma^2 estimated as 2.052e-06:

aic = -190021.2

intercept
0
0

lag(volret[1:18524], 1)
-0.0419
0.0086

log likelihood = 95016.62,

Interpretation

From the aic value it is observed that it is increased from -192947.2 to -190021.2 which
implies that returns of TCS are explained by volume-cum-returns-based technical
indicator contemporaneously is better than model explained with a lag.