lOMoARcPSD|4163173

Tut2Sol - Tutorial ONE

Applied Financial Modelling (University of Wollongong)

StuDocu is not sponsored or endorsed by any college or university

Downloaded by Trung Kiên Tr?n (trantrungkienhstp@gmail.com)
 lOMoARcPSD|4163173

Tutorial 2 (Week 3)

Basic Regression and Hypothesis Testing

Tutorial assignment: Submit Q2* and Q3* to your tutor at the start of the
tutorial

Objectives:
1. Be able to read data in EViews, produce summary statistics, plot graphs, and run simple
linear regressions.
2. Explain the terms BLUE, consistency, efficiency and unbiasedness.
3. Perform hypothesis testing and compute confidence interval
4. Interpret the slope coefficient of a log-log regression as elasticity.

1. Review the materials on Introduction to EViews.

2*. Explain the meaning of “BLUE”.

BLUE stands for “best linear unbiased estimator”. This is with reference to the
ordinary least squares (OLS) estimator in which when the four assumptions of
the classical linear regression model (CLRM) are satisfied, the OLS estimator
has the lowest variance among the class of linear unbiased estimator (i.e. best),
and on average the parameter estimate is equal to the true population parameter
value (i.e. unbiased).

3*. Explain the meaning of an unbiased, efficient and consistent estimator.

Unbiased estimator means that if we were to perform repeated sampling from a

population, the average of the parameter estimate (of the estimator) will equal
the population parameter value.


An estimator  of parameter  is said to be efficient if it is unbiased and no
other unbiased estimator has a smaller variance. If the estimator is efficient, we
are minimising the probability that it is a long way off from the true value of .

When the least squares estimators are consistent it means that the estimates will
converge to their true values as the sample size increases to infinity. For this to
happen it requires the assumptions E(xtut)=0 (i.e. exogeneity assumption of the
regressor) and Var(ut)=2 <  (i.e. finite variance).

4. Using the data file SandPhedge.xls, answer the following questions:

(a) Plot the two series – futures and spot – together. What can you say about the two
series?

Downloaded by Trung Kiên Tr?n (trantrungkienhstp@gmail.com)

 lOMoARcPSD|4163173

1,600

1,500

1,400

1,300

1,200

1,100

1,000

900

800
I II III IV I II III IV I II III IV I II III IV I II III IV I II III
2002 2003 2004 2005 2006 2007

FUTURES SPOT

It can be seen that the two series tend to co-move together. Also, you will notice
that the spot series is leading the futures series.

In time series econometrics, we refer to this as a lead-lag relationship whereby

the spot price is leading the futures price, or the futures price is lagging behind
the spot price.

(b) Run a regression of spot on futures. Report the estimates of your regression.

Dependent Variable: SPOT

Method: Least Squares
Date: 07/27/16 Time: 00:31
Sample: 2002M02 2007M07
Included observations: 66

Variable Coefficient Std. Error t-Statistic Prob.

FUTURES 0.982223 0.023644 41.54289 0.0000

C 21.11071 27.71131 0.761808 0.4490

R-squared 0.964242 Mean dependent var 1159.183

Adjusted R-squared 0.963683 S.D. dependent var 177.9490
S.E. of regression 33.91163 Akaike info criterion 9.915228
Sum squared resid 73599.91 Schwarz criterion 9.981581
Log likelihood -325.2025 Hannan-Quinn criter. 9.941447
F-statistic 1725.811 Durbin-Watson stat 1.902366
Prob(F-statistic) 0.000000

The regression yields: spot = 21.11 + 0.98 futures

(27.21) (0.02)

Downloaded by Trung Kiên Tr?n (trantrungkienhstp@gmail.com)

 lOMoARcPSD|4163173

(c) Suppose you believe that the futures price of an underlying asset and its spot price
tend to co-move one for one. Test this hypothesis in EViews under conventional
significance levels and write your null and alternative hypotheses, and the test
statistic. What is the conclusion of your test?

Set up the null hypothesis, H0: β=1 vs. the alternative hypothesis, H1: β≠1.

To perform hypothesis in EViews, click on View/Coefficient Diagnostics/Wald test

– Coefficient restrictions, then type c(1)=1 and press enter. This produces the output
below. It is apparent from the p-value of the t-statistic that we fail to reject the null
hypothesis of β=1 at all conventional significance levels. Therefore, we conclude that
there is evidence in the data to suggest that spot prices tend to move with futures
prices one-for-one.

Verify that the t-statistic reported in the Wald test is indeed obtained from
(0.982223-1)/ 0.023644 = -0.751863.
Wald Test:
Equation: Untitled

Test Statistic Value df Probability

t-statistic -0.751863 64 0.4549

F-statistic 0.565298 (1, 64) 0.4549
Chi-square 0.565298 1 0.4521

(d) Now re-run your regression of log(spot) on log(futures). Does the logarithmic
transformation change your results in (b) and (c)? How do you interpret the slope
coefficient of log(futures)?

Before running the regression in log-log form, we need to generate the series
lspot and lfutures.

Click on Genr and a window will appear. Type in that window the following
lspot=log(spot)
Then click OK. You will notice that the EViews window now has the variable
lspot.

Repeat for lfutures = log(futures)

Once the new variables which are in logarithm are created, run the regression of
lspot on lfutures. The results are shown below:
Dependent Variable: LSPOT
Method: Least Squares
Date: 07/27/16 Time: 00:39
Sample: 2002M02 2007M07
Included observations: 66

Variable Coefficient Std. Error t-Statistic Prob.

LFUTURES 0.983809 0.025376 38.76852 0.0000

C 0.114411 0.178775 0.639973 0.5245

Downloaded by Trung Kiên Tr?n (trantrungkienhstp@gmail.com)

 lOMoARcPSD|4163173

R-squared 0.959158 Mean dependent var 7.043569

Adjusted R-squared 0.958519 S.D. dependent var 0.156727
S.E. of regression 0.031920 Akaike info criterion -4.021321
Sum squared resid 0.065210 Schwarz criterion -3.954968
Log likelihood 134.7036 Hannan-Quinn criter. -3.995102
F-statistic 1502.998 Durbin-Watson stat 2.012684
Prob(F-statistic) 0.000000

The slope coefficient estimate is different for the log-log regression. It is slightly
larger than the one obtained from the regression in levels.

To perform the hypothesis test of Ho: β = 1, click on View/Coefficient

Diagnostics/Wald test - coefficient restrictions, a window will pop up and type:

C(1)=1

Then click OK.

The hypothesis test result (see below) indicates that there is evidence in the data
to suggest that the log(futures) and log(spot) co-move one-for-one at all
conventional significance levels.

Wald Test:
Equation: Untitled

Test Statistic Value df Probability

t-statistic -0.638040 64 0.5257

F-statistic 0.407095 (1, 64) 0.5257
Chi-square 0.407095 1 0.5234

Downloaded by Trung Kiên Tr?n (trantrungkienhstp@gmail.com)

 lOMoARcPSD|4163173

The p-value of the t-statistic is larger than the significance level at 5%, hence we
fail to reject the null of β=1.

For a log-log regression, the slope coefficient can be interpreted as elasticity. This
means that when futures price increases by 1%, the spot price will increase by
approximately 0.98%.

(e) Based on your results in (d), compute the 95% confidence interval for the slope
coefficient of log(futures).

The formula for confidence intervals of the slope coefficient is

ˆ  t crit  SE ( ˆ )   *  ˆ  t crit  SE ( ˆ )
The lower bound is given by 0.983809 - 1.96*0.02537 = 0.93
The upper bound is given by 0.983809 + 1.96*0.02537 = 1.03

Hence, the 95% confidence interval for the slope coefficient is [0.93,1.03].

It can therefore be seen that if you were to test the null hypothesis of H0: β=1 (i.e.
the slope coefficient equals 1) at the 5% significance level, the value of β=1
clearly lies in the 95% confidence interval implying that you will fail to reject the
null hypothesis. In other words, there is evidence in the data to suggest that the
spot price elasticity is 1.

Downloaded by Trung Kiên Tr?n (trantrungkienhstp@gmail.com)