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The time order defines the x-axis for the scatterplot, and the prices define the y-axis forming the timeplot (Chap- ter 1) shown in Figure 1 04 20 70 60 2 0 24. 20 2» 10 o+ 1988 1986 1990 1992 1994 1998 1998 2000 2002, Yeor FIGURE 1 Timeplot of the price of Enron stock. The timeplot begins in April 1986 when Enron sold for $37.50 per share. The price bounces around after that. Several times it runs up only to fall suddenly Up until the end, the price recovered after each fall Once we've seen Figure 1, it’s possible to wonder why anyone would be surprised by the collapse of Enron. The price of a share fell 50% three times in the 1990s, and it steadily recovered alter the first ‘vo. Perhaps the drop at the end of 1999 was the time to buy shares while the price was low, hoping, for another steady recovery. That might seem like a risky bet. Wasn't it inevitable that one of those drops would be deadly? Some Details: Stock Splits We have to understand the data in order to use sta- tistics. In this case, a simple accounting practice explains the sudden collapses in the price of Enron, stock. To understand these data, we have to learn more about how stocks are priced. Figure 1 doesn’t present the history of Enron ina way that’s helpful to an investor: It displays the prices of a share of stock in Enron at the end of each month. Had we gone to the New York Stock Exchange back then, this plot shows what we would have paid for a share. To appreciate that Figure 1 hides something, sake a look at Figure 2. This timeplot tracks the capi- ‘alized value of Enron, in millions of dollars, through, the end o! 1999 before the collapse. (Capitalized value, ‘or market cap, is the price of a share times the num- ber of outstanding shares. It the total value of all of the stock in a company.) FINANCIAL TIME SERIES 141 35000 7 25000 20000) +5000 10000 000 of 1996 1988 1900 1992 1994 1996 1998 2000 Year FIGURE 2 Matt capitalization of Ero ilions Market Cap ($M) ‘The capitalized value rises steadily, without the sudden falls seen in the value of individual shares. ‘The explanation is that the price of stock tracks only ‘one component of the value of Enron. The price eaves out the number of shares, When the price of a stock increases, it is common for companies to “split” the stock, converting each outstanding share {into two or three. So, if we held one share of XYZ Corporation that was valued at $100 before a split, then we'd have two shares after the split, each worth $50. Our investment is still worth $100, only split be- tween two shares. We'll leave it fora finance class to explain the logic for splitting stocks, but the common, explanation is that lower prices attract more buyers. Stock splits explain the rapid drops in the value of Enron stock seen in Figure 1. The market did not abruptly devalue Enron. Rather, these rapid drops ‘were stock splits. For example, at the end of Novem- ber 1991, Enron sold for about $70 per share. The stock split "2 for 1” in December, and not surpris- ingly, the price at the end of December was about $35 per sI Dividend payments also add variation to stock prices. Let's go back to our $100 investment in one share of stock. If thats the price today and the com- pany pays a dividend of $5 per share tomorrow, then the value of each share drops to $95. We were paid the other $5 in cash. Like splits, dividends cause prices to change but don't change the value of our investment. We have to account for splits and dividends in or der to build a useful plot. Splits and dividend pay- ments add variation to the prices, but these do not materially affect the value of the investment. We would not have lost money in 1991 when Enron's stock split; we'd simply have had twice as many shares, each worth half of the original price. A more informative plot removes these accounting artifacts. We have to adjust for the splits and track the wealth of an investor who started with one share. 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For exam- le, we can identify the price of a stock in the th ow of the data table by 2. The symbol P.- rep- “sents the price in the prior row (the end of the revious month). The change in price during this jonth is P ~ P,., The return on the stock is then fe Bes Pa $41.25 — $43.125 $43.125 = 0.0435 he percentage change multiplies the return by 100, loss of 4.35%. imple Time Set he timeplot of the monthly percentage changes in fgure 4 conveys a different impression of the risks ssociated with investing in Enron. 30 20 1985 1988 1990 1992 1994 1996 Year IGURE 4 Monthly percentage changes in price of Enron stock These hardly look like the same data, What hap- cned to the smooth upward growth evident in jure 2 and Figure 3? Where did all the rough, regular ups and downs come from? By thinking of investing as a series of bets, we re- jove the compounding that happens to investments nd concentrate on what happens each month anew. fost of these monthly bets made money. After all, the rice went up on average. But we can also see quite a nv losing bets. Bets on Enron were hardly a lock to sake money, We can also appreciate the magnitude of hhat happened in October 1987: Stock in Enron fell early 30% that month, That wasnt the only big drop er During August 1998, stock in Enron fell 20% ‘There's another key difference between the timeplot Fthe prices (Figure 3) and the timeplot of percentage hanges (Figure 4). Which plot shows a pattern? We ould say that the timeplot of percentage changes in. non stock is simpler than the timeplot of the prices ecause there's no trend in the returns. Simple in this 1998 2000 FINANCIAL TIMESERES 143 sense does not mean “constant.” All of that irregular, vigzagging variation in Figure 4 looks complicated, but that’s common in simple data. We say that these data are simple because it is easy to summarize this sort of variation, There’ variation, but the ap- pearance of the variation is consistent. Some would call this variation “random,” but we will see in later chapters that random variation often has patterns. Because there's no pattern that would be hidden, we can summarize simple variation with a histogram. Simple variation is “histogrammable.” It can be hard to decide if a timeplot shows simple variation because people find it easy to imagine pat- terns. The visual test for association works nicely in this context, In Chapter 6, we showed several scram- bled scatterplots of energy prices. If the original ean easily be identified, there's a pattern. Ifnot, the varia- tion is simple and can be summarized with a histo- gram. To use the visual test for association with time series, mix the order of the data as though shuflling adeck of cards. If the timeplot of shuffled data looks different from the original timeplot, then theres a pattern and the variation is not simple, Figure 5 compares the timeplot of the price of — Enron stock to the plot of the data after shuffling. bla FIGURE 5 It's easy to recognize the timeplot of prices. jimple Variation in simple data lacks 2 pattern, making it appropriate to be summarized in a histogram.9018 UOWU Jo @atid ou up saBueyp aSewesved jo we6orsy g ENDL oe ot kee o1 oz 8 oe 2 op os 0 “erep ayp Jo ayu09 3111 a8P20] 01 1040x0q & sppe puv moxe| feIuGZL0H,. 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How does this compare to the fraction of times that the stock fell by 6% or more in the data? .. If we invest $1,000 in Pfizer for one month, what is the Value at Risk based on the Em- pirical Rule? Interpret the VaR in your own words.