Assignment #1

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Date: February 6 , 2024
Class: ECON 435/635 – Financial Economics and Quantitative Methods
Instructor: Dr. Liam D. Kelly
Due: 11:59pm on Friday February 16th, 2024

*Please answer all questions as clearly as possible. Assignments should be typed and submitted as a single
pdf. For any math questions, you can include photos of your written work in the document, but make sure
they are clear and easy to read. Importantly, while you may discuss the assignment with your classmates,
you must complete the questions on your own. In order to get full marks, you must fully explain your
answers, show all of the steps you took to get your answers, and fully label any graphs and figures. In
addition, make sure to include your code for any empirical exercises with clear comments throughout the
code explaining each step and provide references for any cited material. Assignments should be
professionally formatted and submitted to Moodle by the due date. Late assignments will not be accepted.

Q1: Using the statistical software of your choosing (not excel), download weekly data for META for the
years 2013 to 2023: (15)
a. Plot the time series, with correct labels and formatting and indicate whether this series has a trend
(1)
b. Plot the ACF and PACF and discuss the correct model of this time series (e.g., AR(1),
ARIMA(0,1,1), etc.) (2)
c. Estimate the model identified in part (b) and discuss the results briefly (4)
d. Plot the ACF and PACF of your residuals for the model estimated in part (c) and discuss whether
there is any remaining serial correlation (4)
e. Finally, use the augmented dickey fuller test to assess the stationarity of this dataset and discuss
the results (Make sure to fully explain how you specified the test) (4)

Q2: Consider the standard random walk model, without drift: 𝑦𝑡 = 𝑦𝑡−1 + 𝑢𝑡 (15)
a. Is the random walk model stationary? Prove and explain fully. (5)
b. Is the random walk model difference-stationary? Prove and explain fully. (5)
c. What are the odds of an increase in 𝑦𝑡 at time 𝑡 + 1 and the odds of a decrease in 𝑦𝑡 at time 𝑡 + 1
(3)
d. What is the best estimate of the next period’s price? Explain why. (2)

Q3: Consider the following time series models. Classify each model into an AR(p), MA(q), ARMA(p,q),
or ARIMA(p,d,q) and briefly discuss any important characteristics of each: (15)
a. 𝑦𝑡 = 𝑦𝑡−1 + 𝑢𝑡
b. 𝑦𝑡 = 0.6𝑦𝑡−1 + 𝑢𝑡
c. 𝑦𝑡 = 1.1𝑦𝑡−1 + 𝑢𝑡
d. 𝑦𝑡 = 0.5 + 0.2𝑦𝑡−1 + 0.2𝑢𝑡−1 + 𝑢𝑡
e. 𝑧𝑡 = 0.35𝑧𝑡−1 + 0.9𝑢𝑡−1 + 𝑢𝑡 , where zt = 𝑦𝑡 − 𝑦𝑡−1

Q4: Suppose that there are only two stocks in the stock market. Stock A sells for $20 and has 100
shares outstanding. Stock B sells for $40 and has 200 shares outstanding. Assume that there is a
risk-free asset. (10)
a. What is the market portfolio in this hypothetical economy? (4)
b. If the beta of Stock A is 1.2, what is the beta of stock B? (4)
c. What is the interpretation of beta? (2)

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Q5: The below table contains data for two publicly traded stocks. The T-Bill rate is 2% and the market
risk premium is 5% (10)
Company A B
Forecasted return 12% 11%
Standard deviation of returns 8% 10%
Beta 1.5 2
a. What would be the fair return for each company according to the CAPM? (6)
b. Characterize each company as undervalued (underpriced), overvalued (overpriced), or fairly
priced. (3)
c. What is the difference between the fair and actual (or expected) rates of return on a stock called?
(1)

Q6: Consider the efficient market hypothesis: (15)

a. Define and briefly explain the three forms of the efficient market hypothesis and their practical
implications for investors. (6)
b. Inspect the three graphs below and explain what you see in terms of market efficiency and its
three forms (9)
I. The S&P 500’s current and one-day lagged returns during August 2-4, 2019

II. The hypothetical path of a stock’s cumulative abnormal return (CAR) 10 days before a
public announcement and 5 days after the announcement

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 III. Same as II above

Q7: Using the statistical software of your choosing (not excel), download weekly stock price data for three
publicly traded companies from the same broad sector/industry (e.g., energy, healthcare/pharmaceuticals,
etc.) for 2018-2023: (10)
a. Plot all three series together and make sure to include a formal legend and accurate labels (6)
b. Briefly discuss how COVID-19 impacted these three companies, highlighting any similarities or
differences (just broad qualitative impacts, not specific impacts or estimates). (1)
c. Calculate the simple return for each stock for 2018-2023 (3)
a. I have not explicitly taught you how to do part (a) or (c), it is up to you to search the
internet, read relevant forums, and find out how to do it. Part of learning to code is
learning how to find solutions to issues or challenges that inevitably arise.

Q8: Provide a formal citation for one academic article from the Journal of Financial Economics (from any
year) that relates to your chosen research project in some way and briefly summarize the key contribution
of this article (For group projects, each group member must select a different article). (UG=10/GR=5)
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Q9: For Graduate Students only: Prove that the expected value of an AR(1) process equal 1−𝜙 (GR=5)
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