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Problem # 1:
a. Used Excel Addins function Analysis ToolPak > Data Analysis > Regression to do the
estimation.
This is a multiple linear regression with a) S&P 500 returns and the industry returns as
independent variables b) stock returns is the dependent variable
The linear regression model would be as follows:
yt : stock returns
40
ANOVA
df
Regression
Residual
Total
Intercept
S&P Return
Industry Return
2
37
39
SS
3.438999416
0.548033658
3.987033074
0.021423527
0.021616345
3.006318797
1.856435223
1.293186386
1.863567292
MS
F
1.719499708 116.0904778
0.01481172
t Stat
P-value
0.991079976 0.328083957
1.619404092 0.113853999
0.693930609 0.492059792
Significance F
1.1374E16
Lower 95%
Upper 95%
0.065222403
0.75517626
0.022375349
6.767813853
5.069132386
2.482759615
0
1
2
Variable
Intercept
S&P 500
Returns
Industry
Returns
)
SE(
Tratio
Results
H1 : 0 0
0.0214
0.0216
0.991
Dont Reject
H 0 : 1 0
H1 : 1 0
3.0063
1.8564
1.619
Dont Reject
H 0 : 2 0
H1 : 2 0
1.2932
1.8636
0.694
Dont Reject
Null
Alternate
H 0 : 0 0
R^2 equals 0.8625, which means that our model using S&P return and industry return as the
two variables can explain 86.25% of the change of stock return. The rest 13.75% will be
explained by other factors contained in the residual term.
We can observe is there is supposed to be a positive relationship between stock returns and
S&P, and stock return and industry. However, the results showed the relationship between
stock return and industry to be negative. It could be because the two variables S&P returns
and industry have high correlation
Finally, we can say that there is a strong evidence of presence of multicollinearity because of
a) high value of R (very close to 1) b) high coefficient standard errors c) low tstat values
b) Summary Output for regression:
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.998144831
0.996293104
0.996195554
0.010594144
40
ANOVA
Regression
Residual
Total
df
1
38
39
SS
MS
F
1.146283555 1.1462836 10213.164
0.004264964 0.0001122
1.150548519
Significance F
8.33979E48
Intercept
S&P Return
Coefficients
0.001748561
0.994324825
Standard Error
t Stat
Pvalue
0.001860176 0.9399979 0.3531558
0.009838936 101.0602
8.34E48
Lower 95%
0.002017168
0.974406941
From the results above, we conclude that the regression model is:
where x
0.001749 0.994324
(0.0019)
(0.0098)
S&P 500 returns and x Est. industry residual returns
We calculate the Variance Inflation Factor (VIF) for the S&P 500 returns coefficient:
The value calculated is 270.2703. We know that if the VIF is greater than 10, especially
greater than 100, the multicolinearity is very severe. This means, our two explanatory
variables for the previous model are very highly correlated with each other
c. Using the Residual Output from the previous regression, we can see the residuals below:
Observation
1
2
3
4
5
6
Predicted Y
0.147095172
0.185443165
0.241892575
0.334743231
0.07299174
0.128050103
Residuals
0.001246474
0.009831554
0.010819001
0.003659931
0.016111605
0.002058562
Upper 95%
0.00551429
1.01424271
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
0.105973634
0.113337116
0.19989625
0.115626625
0.230621283
0.154032544
0.032821212
0.213824835
0.270626984
0.050881108
0.140279246
0.191868764
0.040601715
0.278487896
0.047512165
0.088014916
0.014522553
0.320552289
0.24740871
0.25757743
0.29633236
0.142540313
0.060997012
0.143734063
0.211355303
0.26444815
0.044672784
0.083657206
0.114833153
0.029948964
0.368343125
0.298123021
0.132979474
0.106084068
0.007820651
0.003262435
0.003691056
0.014670343
0.000158338
0.015014626
0.004198292
0.000772743
0.009437844
0.007597783
0.002026339
0.019505077
0.01511179
0.002256866
0.010003142
0.002821106
0.000156001
0.001174978
0.001446474
0.005110541
0.022714849
0.012553393
0.011168861
0.018855007
0.020034081
0.016173478
0.003012539
0.007781895
0.00763726
0.008757749
0.006879428
0.001907871
0.014286527
0.007015343
Now substitute the residuals above as the second explanatory variables. And run the
regression of Stock Returns against those of the S&P500 and the industry.
df
2
37
39
SS
3.438999416
0.548033658
3.987033074
MS
1.71949971
0.01481172
F
116.0905
Significance F
1.137E16
Intercept
S&P Return
Residuals
Coefficients
0.023684743
1.720471469
1.293186386
Standard Error
0.021369327
0.11302773
1.863567292
t Stat
1.1083523
15.2216759
0.6939306
Pvalue
0.274863
1.64E17
0.49206
Lower 95%
0.066983
1.4914555
5.069132
Upper 95%
0.0196136
1.9494874
2.4827596
ANOVA
df
Regression
Residual
Total
1
38
39
SS
3.431866985
0.555166089
3.987033074
Intercept
0.023684743
0.021223049
S&P 500
1.720471469
0.112254024
MS
3.431866985
0.014609634
t Stat
1.115991539
15.32659059
Significance
F
F
234.904379 7.4422E18
Pvalue
Lower 95%
Upper 95%
0.06664856 0.019279073
0.2714333
7.44218E
18 1.49322508
1.947717861
. .
(0.0212) (0.112)
Note the following:
Stock returns have a positive relationship with 1.7205 times S&P500 returns
1.7205 means when S&P return increases by 1 percent, stock return will increase by 1.7205
percent.
R^2 equals 0.8608, it means our model using S&P return as the variable can explain 86.08%
of the change of stock return. The rest 13.92% will be explained by other factors contained
in residual.
Fstatistic equals 3.4319/0.0146=234.9044, which is greater than the critical value F(2,37),
so we would reject the null hypothesis
If we compare the results of this regression with part c), we find out the intercept and the
slope coefficient for the S&P Return, are the same for both models. R^2 is smaller and F
statistics is greater. This means:
The linear regression models are the same with the exception of the residual
orthogonalized component.
The residual component provides little to no additional value in explaining the variation of
stock returns and can be disregarded. We can conclude that S&P 500 returns are significant
and it can describe most of the variation in stock returns.