Quantitative finance Assignment Solved

QUANTITATIVE FINANCE PROJECT
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TABLE OF CONTENTS
TASK A...........................................................................................................................................1
Discussing CAPM theory and related literature..........................................................................1
TASK B...........................................................................................................................................1
(1) Regression analysis to compute beta.....................................................................................1
(2) T test......................................................................................................................................3
(3) CAPM analysis......................................................................................................................5
(4) CAPM and sensitivity to industry change.............................................................................6
TASK C...........................................................................................................................................6
(1) Fixed and random effects......................................................................................................6
(2) Model for panel data regression analysis..............................................................................7
REFERENCES..............................................................................................................................................12
Figure 1GSK and FTSE regression.................................................................................................1
Figure 2HIK and FTSE regression..................................................................................................2
Figure 3IAG and FTSE regression..................................................................................................2
Figure 4 IHG and FTSE regression.................................................................................................3
Figure 5FTSE and GSK T test.........................................................................................................3
Figure 6FTSE and HSK T test.........................................................................................................4
Figure 7FTSE and IAG T test..........................................................................................................4
Figure 8FTSE and IHG T test..........................................................................................................5
Figure 9CAPM for GSK,HIK,IAG and IHG...................................................................................5
Figure 10Hausman test for GSK and FTSE....................................................................................7
Figure 11Panel regression for FTSE and GSK................................................................................8
Figure 12Hausman test for HIK and FTSE.....................................................................................8
Figure 13Panel regression for HIK and FTSE.................................................................................9
Figure 14Hausman test for IAG and FTSE.....................................................................................9
Figure 15Panel regression..............................................................................................................10
Figure 16Hausman test for IHG and FTSE...................................................................................10

Figure 17Panel regression..............................................................................................................11

TASK A
Discussing CAPM theory and related literature
CAPM refers to the capital asset pricing model which help investor to compute return it
must expect at least to earn for risk taken on investment. Expected return given by CAPM model
is also know as cost of equity. Many scholars assume that CAPM model is ineffective because of
below given assumptions. Investors hold diversified portfolio: It is assumed that user have diversified portfolio and
unsystematic risk completely ignored which make model less effective (Fernandez,
2015). Investor can borrow and lend at RFR: Every time investor can not borrow or lend at
RFR. Thus, in that situation CAPM prove ineffective. Perfect capital market: It is assumed that all securities are priced correctly which is
wrong as shares always become overvalue or undervalue.
TASK B
(1) Regression analysis to compute beta
Figure 1GSK and FTSE regression
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Figure 2HIK and FTSE regression
Figure 3IAG and FTSE regression
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Figure 4 IHG and FTSE regression
(2) T test
FTSE GSK
Figure 5FTSE and GSK T test
FTSE HSK
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Figure 6FTSE and HSK T test
FTSE IAG
Figure 7FTSE and IAG T test
FTSE IHG
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Figure 8FTSE and IHG T test
T Test interpretation
In case of GSK p value 0.62>0.05, 0.15>0.05 in case of HSK, 0.98>0.05 in case of IAG
and 0.39>0.05 in case of IHG. It is clear that for no company significant difference is observed
and FTSE as well as all firms are generating same rate of return.
R square interpretation
R square value in case of GSK and FTSE is 0.0 which means zero percentage of variation
of GSK is explained by FTSE. In case of HIK value is 10% which means that only 10% of
variation of HIK is explained by FTSE. In case of IAG same trend is observed. In case of IHG R
square value is 37% which is higher then other and means that 37% of total variation in IHG is
because of FTSE.
(3) CAPM analysis
Figure 9CAPM for GSK,HIK,IAG and IHG
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Expected return on all stocks is almost same and there is not a big difference. It can be said that
return of almost 5% is required by all stocks given above. Merits and demerits of CAPM model
is given below.
Merits
 Ease of use: It is easy to apply CAPM model as one need to obtain beta value which is
available on multiple platforms. RFR assumed on basis of treasury bill rate. On basis of
historical return market return can be assumed. Thus, non-technical person can easily
perform CAPM calculation because of simple formula and easy availability of
information (Campbell and et.al., 2018).
 Systematic risk measurement: CAPM take in to account systematic risk which means
that if investor is giving due importance to systematic risk then in that case it can in better
way estimate minimum return need to be gained on investment made.
Demerits
 RFR: Return on short term security always keeps on changing consistently. Hence, on
basis of CAPM model accurate estimate of required rate cannot be made.
 Return on market: Investor assume that return on market will be positive. However,
many time market start declines for long term and in that situation CAPM model result
cannot be assumed reliable.
(4) CAPM and sensitivity to industry change
Results are sensitive to industry characteristics because with change in industry company
performance greatly affected. Thus, change in all firms belonging to particular sector lead to
change in overall Index of specific sector. It can be said that CAPM results are sensitive to
market risk.
TASK C
(1) Fixed and random effects
In panel data regression two terms are common which are random and fixed effects. In any
panel model every time fixed and random variable are picked. Fixed variable refers to the
variable whose value almost remain same like age and gender etc. On other random effects are
one where variable value keeps on changing consistently (Fixed Effects / Random Effects / Mixed
Models and Omitted Variable Bias., 2019). This reflect that both variables are different from
each other and have different significance. In panel regression it is very hard to estimate that
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which of model either fixed or random is best one. Hence, in order to solve this problem
Hausman test is used by the analyst and on basis of its value best model is picked for
investigating relationship. One of major difference between random and fixed effect is that in
case of former one unobserved variable must be independent of observed variable. On other
hand, in case of fixed model unobserved variable are allowed corelated to observed variable.
This is one of major difference between both models.
(2) Model for panel data regression analysis
Figure 10Hausman test
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Figure 11Panel regression
Value of chi square in Hausman test is above 0.05 and due to this reason random effect model is
chosen. P value is less then or equal to 0.05 in case of X1,X2 and X4 which means that in case of
these variables coefficient value is distant from zero. On other hand, in case of variable X3 value
of level of significance is 0.170.0.05 and this means that coefficient value is almost nearby to
zero.
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REFERENCES
Books and journals
Campbell, J.Y. and et.al., 2018. An intertemporal CAPM with stochastic volatility. Journal of
Financial Economics. 128(2). pp.207-233.
Fernandez, P., 2015. CAPM: an absurd model. Business Valuation Review. 34(1). pp.4-23.
Online
Fixed Effects / Random Effects / Mixed Models and Omitted Variable Bias., 2019. [Online].
Available through:< https://www.statisticshowto.datasciencecentral.com/experimental-
design/fixed-effects-random-mixed-omitted-variable-bias/>.
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