Mathematics for Economics and Finance (Fall 2023)

Assignment 1
Professor: Norman Schürhoff
Due date: 5 November 2023

Section I (25 points)

1. Look at the following pairs of statements and determine if they are logically equivalent.

(a) ˜(p∧q), (˜p) ∨ (˜q),

(b) (p ⇒ q)∧(q ⇒ r), p ⇒ r,
(c) p ∨ (q ∧ r); (p ∨ q) ∧ (p ∨ r),
(d) A ⇒ B ⇒ ˜C, C ⇒ ˜(A ⇒ B).

2. Prove that function h : R → R, defined by h(x) = x3 − x, is non-injective.

3. Discuss the properties of injectivity, surjectivity, and bijectivity for the function

f : R → R, f (x) = ex .

4. Use one of the proof methods seen in class to prove the following propositions:
(a) Let A, B ⊆ RN be convex sets. Then A ∩ B is convex. Prove that A ∪ B doesn’t have to be
convex.
(b) Prove the following statement for n ≥ 1 using mathematical induction:
n
X n(2n − 1)(2n + 1)
(2k − 1)2 =
3
k=1

Section II (15 points)

Consider the following matrix:  
1 2 3 4
 2 3 1 2 
 
 1 1 1 −1 
1 0 −2 −6
1. Compute the determinant, the cofactors, the trace, the kernel, and the adjoint and inverse matrices.
Do the exercise “by hand.”
2. Use a computer software like Matlab/Octave/Excel/etc. to do the computations. Also, perform
a spectral and Cholesky decomposition of the matrix using computer software. Please enclose the
code/spreadsheet/etc.

Section III (30 points)

The dataset dataq2.csv contains daily returns for 11 assets. Use the dataset provided with the assignment
and answer the following questions:
1. Assume that the market is made up of the 11 assets. Is the market arbitrage free? For this purpose,
a market is said to be arbitrage free is there exists no linear dependence between the returns of the
assets. Explain.

1
 2. Now drop the 11th asset and answer the following:
(a) What is the average daily return of an equally weighted portfolio?
(b) What is the variance-covariance matrix?
3. Now consider a factor analysis of the returns. Factor analysis allows for dimension reduction by
retaining only the top eigenvalues (factors) that capture the most significant variation in the data.
This reduces the dimensionality of the problem while preserving the essential information.
(a) Decompose the variance-covariance into its eigenvalues and eigenvectors.
(b) Show that each eigenvector represents a linear combination of the original variables, and each
eigenvalue represents the variance explained by its corresponding eigenvector.
(c) Perform factor analysis using 1, 2, 3, 4, 5, and 6 factors without rotation. How many factors
are actually required to perform factor analysis? Give reasons. (Hint: Check eigenvalues. The
number of factors is the number of eigenvalues exceeding 1. This is known as the Kaiser Rule.
The logic is that a factor with eigenvalue greater than 1 explains more variance than a single
observed variable.)
(d) Factor rotation helps to make the factors more interpretable. Varimax rotation is an orthogo-
nal rotation in which assumption is that there is no intercorrelations between components. In
contrast, oblique rotation is more complex, and can provide more superior results. See https://real-
statistics.com/linear-algebra-matrix-topics/varimax/. Perform factor analysis using the required
number of factors with varimax rotation. Report the factor loadings. Interpret the factor loadings.

Section IV - (15 points)

1. Is function f (x, y) = ln (ex + ey ) convex? Is it strictly convex?
2. Calculate
π
+ cos π2 ex



sin 2x
lim 3π


x→0 cos 2 cosx

Hint : use Taylor’s theorem and Taylor series representation.

R x dx
3. Evaluate: √xe1+e x

Section V - (15 points)

The economy can be in three states: boom, recession, and normal growth. There is a 20% chance that when
the economy is in boom next period it will move to a normal growth regime and a 5% chance that the period
of boom will lead to recession. If the economy is in a normal growth state there is a 2% chance that it will
boom next period and a 8% chance that it will fall into recession. For the economy which is currently in
recession there is a 20% chance it will become normal next year and a 10% chance that the economy will
boom. Today the economy is in recession.
1. What is the probability that in 2, 5, 10 years the economy will be in boom or recession?
2. What happens with these probabilities as t −→ ∞.
Hint: Use a matrix decomposition technique to show your computations.