MSc Finance & MSc IWM: Financial Econometrics Assessed Exercise
Instructions
Please complete the Exercise below and submit:
• Point 1. before 3/2/2020 at 15:59 on The Hub. Submission will only be possible via The Hub. Late submissions will not be considered.
• Points 2. and 3. before 2/3/2020 at 15:59 on The Hub. Submission will only be possible via The Hub. Late submissions will not be considered.
Please complete the exercise within your allocated syndicate groups and submit one solution for each group. The maximum number of pages for this exercise is 5, excluding tables and graphs. Papers exceeding the length limit will only be evaluated on the first 5 pages.
Exercise – Stocks as Lotteries
This empirical exercise is based on the work by Bali, Cakici and Whitelow (2011).
Portfolios and factors construction
Let’s construct tradable portfolios from the given dataset.
1. Upload data (filename: assignment data18.RData) in R.
2. Data contain daily close prices, standard industrial classification (SIC) code and market cap (ME) for a large cross-section of stocks in the US. The first row contains the permno of any given stock, whereas the second row contains the date, the third the SIC code, the fourth the closing price, and the fifth market cap.
3. Upload the five Fama-French factors monthly data.
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
(Link).
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Trading strategies
1. Form decile portfolios following the methodology of Bali, Cakici and Whitelow (2011), considering the effect of the SIC code. Report the average number of stocks and the average ME within each decile for each SIC code, over the con- sidered sample size.
(30% of mark)
2. Calculate the returns of the maxing out strategies, considering the effect of the SIC code. For any of the strategies, report summary statistics, Sharpe ratios, t-ratios, maximum drawdowns, a plot of the cumulative returns over time. Com- ment on the different performances and risk-return profiles of the strategies.
(45% of mark)
3. Run regressions of each strategy’s returns on the five Fama-French factors and
comment on the sign, size and the significance of the estimated alphas and betas.
(25% of mark)
References
Bali, T., N. Cakici and R. Whitelaw (2011). Maxing out: Stocks as lotteries and the cross-section of expected returns. Journal of Financial Economics, 99, 427-446.
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