McMaster University

DeGroote School of Business

MFIN 705

Assignment 3
Due December 1.

Hand in a pdf copy of your: 1) computer output, 2) your R code in a plain text
file and 3) a separate write-up of the answers to the following questions on Avenue,
Assignment 3. Each student’s write-up should be done independently.

1. (15) Explain how the GARCH model and the stochastic volatility model are similar
and how they differ. Explain how the models can be estimated.

2. (55) This question will consider the single index model

rt = µ + βrm,t + ut ,

where rt is daily returns for WMT and rm,t is the daily return for SPY. The data
range is from 2005-01-01 2023-08-01.

(a) (10) Use OLS to compute the beta for WMT. Why is beta useful in finance?
(b) (20) If the second conditional moments of (rt , rm,t ) are time-varying define a
time-varying beta in this setting and estimate it using the model in the posted
bekk.r code. Report model estimates and any evidence of time variation in
beta.
(c) (5) Compare the constant beta with the time-varying beta with a plot.
(d) (20) Which beta captures more of the variation in rt ?

3. (30) This question requires you to download and compute daily returns for 15
stocks from yahoo.

(a) (10) Explain what principle component analysis is and why it is useful.
(b) (20) Perform principle component analysis on your selected stocks and report
your results. Use a scree plot to select the number of components you would
use.