Statistics for Financial Engineers, Winter 2016

Professor Martin Lettau

Problem Set 8
Due March 18, 2016 6:00pm
To be submitted via bCourses
1. For the matrix

"

1
X =
4

1
2

#
1 1
,
3 5

compute P = X(X 0 X)1 X 0 and M = I P.

(a) Verify that M P = 0.
"
#
1 3
(b) Let Q =
, compute the P and M based on XQ instead of X.
2 8
2. In the linear regression Y = X + e with E(ei |xi ) = 0, it is known that
the true satisfies the restriction
R = 0
where R is a q k matrix with q < k. Consider the estimator

= (X 0 X)1 R0 [R(X 0 X)1 )R0 ]1 R.

(a) Show that R = 0.

(b) Find E(|X).

(c) Find V ar(|X).

[Hint: First write as a linear function of ].

(d) Give an expression for a valid standard error for the elements of .
You do not need to give a proof of validity.
3. Show that the value of 1 in
Pn
(y y)(xi x
)
i=1
Pn i
2
(x

)
i=1 i
Pn
Pn
where x
= 1/n i=1 xi and y = 1/n i=1 yi , can be rewritten in each of
the following three forms:
1 =

(a)

Pn
xi yi nxy
1 = Pi=1
n
2
x2
i=1 xi n
1

(b)

Pn
(xi x
)yi

1 = Pi=1
n
)2
i=1 (xi x

(c)

Pn
xi (yi y)

1 = Pi=1
n
)2
i=1 (xi x

4. Suppose that both the least-squares line and the least-squares parabola
y = 0 + 1 x + 2 x 2 + e
were fitted to the same set of points. Explain why the sum of the squares
of the deviations of the points from the parabola cannot be larger than
the sum of the squares of the deviations of the points from the straight
line.
698 Chapter 11 Linear Statistical Models

5. Consider the observed

values
invalues
the following
table.
a func10. Consider
againpresented
the observed
presented in
Table Fit 11.
Consider again the observed values presen
2y = x + x + x2
11.4,
and consider also the two functions that
11.4.
Fit
a
function
having
the
form
tion having the form y = 1 x1 +2 x2 +3 x2 to these
by
1 1 values
2 2
3 2the method
to these values in Exercises 9 and 10. Which o
to these values by the method of least squares.
of least squares.
functions fits the observed values better?
Table 11.4 Data for Exercise 9
i

xi1

xi2

yi

xi1

xi2

yi

100

113

120

144

100

118

120

138

110

127

130

146

110

132

130

156

120

136

10

130

149

Figure 5.1: Data for 5.

11.2 Regression

Sec. 11.1,(under
we introduced
the method
6. Download the file Data_PG_UL.csv from In
bCourses
the Files
tab). of least squares. This method co
coefficients for a linear function to predict one variable y based on other va
The spreadsheet includes monthly returns
index
(Rm ), that the y values are observed valu
x1,for
. . . the
, xk .CRSP-VW
In this section,
we assume
random variables.
this case, there is a statistical model in wh
Proctor & Gamble (RP G ), Unilever (RUcollection
Consumer
Goods In
index
L ) and aof
method
of
least
squares
turns
out
to produce the maximum likelihood es
(RHH ). In the lecture, we discussed regressions for Proctor & Gamble
of the parameters of the model.
using the finite sample results under normality. The problem set asks you
to do the same analysis for Unilever.

Regression Functions

(a) Run the regression

Pressure and the Boiling Point of Water. Forbes (1857) reports the resul
periments that were trying to obtain a method for estimating altitude.
RU Lt Rf t = + (Rmt Rf t ) + et
is available for altitude in terms of barometric pressure, but it was diffic
a barometer
to high altitudes
2 . in Forbes day. However, it might be ea
Report the coefficient estimates, theelers
R2 and
the adjusted
R
to carry
a thermometer
and measure the boiling point of water.
contains the measured barometric pressures and boiling points of water
periments. We can use the method of least squares to fit a linear relationsh
2
boiling point and pressure. Let yi be the pressure for one of Forbes ob
and let xi be the corresponding boiling point for i = 1, . . . , 17. Using
Table 11.5, we can compute the least-squares line. The intercept and slo
spectively, 0 = 81.049 and 1 = 0.5228. Of course, we do not expect th
y = 81.049 + 0.5228x precisely gives the relationship between boiling p
pressure y. If we learn the boiling point x of water and want to compute
tional distribution of the unknown pressure Y , is there a statistical model
us to say what the (conditional) distribution of pressure is given that the b
Example
11.2.1

(b) Construct a scatterplot of UL returns (on the y-axis) and CRSP-VW

returns (on the x-axis) as well as the regression line.
(c) Compute the variance-covariance matrix of the OLS coefficients under
the assumption of homoskedasticity.
(d) Compute the 90%, 95% and 99% confidence intervals using the variancecovariance matrix.
(e) Use t-tests to test the null hypothesis that each regression coefficient
is individually equal to 0.
(f) Run the regression
RU Lt Rf t = + (Rmt Rf t ) + (RHHt Rf t ) + et
2 , the
and report the coefficient estimates, the R2 , the adjusted R
variance-covariance matrix of the OLS coefficient under the assumption of homoskedasticity, the 90%, 95% and 99% confidence intervals
and the t-tests.