BDU, CoBE, Department of Economics
Assignment for Financial Econometrics-2 (40%)
N.B: The answer should be written in your own hand writing
Supposes a student of Accounting and Finance wants to model “The attitude of parents towards family size preference”. In this regard, the student wants to regress family size (Y) on children as wealth (X2i) and son preference (X3i) using 1000 sampled households in the town of Gondar. As his data is cross – section, the student wants to test his model for hetroskedasticity problem.
What is / are the consequences of hetroskedasticity?
Suppose this student wants to conduct the White test for hetroskedasticity.
Write the null & the alternative hypothesis?
Suggest the basic steps in conducting the White test?
a) What do you understand by the term ‘autocorrelation’?
An econometrician suspects that the residuals of her/his model might be autocorrelated. Explain the steps involved in testing this theory using the Durbin–Watson (DW) test.
Calculates a value for the Durbin–Watson statistic of 0.95. The regression has 60 quarterly observations and three explanatory variables (plus a constant term). Perform the test. What is your conclusion?
What might Ramsey’s RESET test be used for? What could be done if it were found that the RESET test has been failed?
a) Why is it necessary to assume that the disturbances of a regression model are normally distributed?
In a practical econometric modeling situation, how might the problem that the residuals are not normally distributed is addressed?
Given a simple linear regression function as: , where ei is the error term. Show the Linearity and Unbiasedness property of , where is an estimator for the population parameter ?2.
The model Yi=? +?1X1i +?2X2i +?3X3i +Ui is to be estimated from a sample of 20 observations.

RSS=12.05

Using the information above
Calculate the coefficient estimates
The standard errors of the coefficient estimate.
The covariance of ?1 and ?2 and ?2 and ?3
a) Explain the term ‘parameter structural stability’?
b) A financial econometrician thinks that the stock market crash of October 1987 fundamentally changed the risk–return relationship given by the CAPM equation. He decides to test this hypothesis using a Chow test. The model is estimated using monthly data from January 1980–December 1995, and then two separate regressions are run for the sub-periods corresponding to data before and after the crash. The model is
r_t=a+ßR_mt+u_t
so that the excess return on a security at time t is regressed upon the excess return on a proxy for the market portfolio at time t. The results for the three models estimated for shares in British Airways (BA) are as follows:
1981M1–1995M12
r_t=0.0215+1.491R_mt, RSS=0.189 T=180
1981M1–1987M10
r_t=0.0163+1.308+1.308R_mt, RSS=0.079 T=82
1987M11–1995M12
r_t=0.0360+1.613R_mt, RSS=0.082 T=98
What are the null and alternative hypotheses that are being tested here, in terms of a and ß?
Perform the test. What is your conclusion?