hw1 Wenbo Zhang

Financial Econometrics Homework 1

Dr. Cai
Wenbo Zhang
FINN 6219 Homework 1 Wenbo Zhang

1. Download weekly price data for IBM and Microsoft stock.

IBM (P1t) 01/02/62 – 01/15/08
MSFT(P2t) 03/13/86 – 01/15/08

a) Create a time series of continuously compounded weekly returns for IBM and
Microsoft.

Use the equation: , we can get the returns series.
b) Use the constructed weekly returns to construct a series of monthly returns. You
may assume for simplicity that one month consists of four weeks.
t =4(k −1)+4
Use the equation: mi,k = ∑ r , where i = 1,2, k = 1,2,3, , we can get the
t =4(k −1)+1 i,t
returns series.
c) Construct a graph of stock price series (P1t, P2t) and returns series (r1t, r2t).
€
600
150
500
400
100
p2t
p1t
300
200
50
100
0 500 1000 1500 2000 0 200 400 600 800 1000
Time Time

2


0.6
1.0
0.4
r2t
r1t
0.2
0.5
0.0
0.0
-0.2
0 500 1000 1500 2000 0 200 400 600 800 1000
Time Time

d) Compute and graph the rolling estimates of the sample mean and variance for stock
prices and returns. In computation of rolling estimates, you may use the last quarter
of data.
160
600
140
500
120
400
100
p1rm
p2rm
300
80
200
60
40
100
20
0 500 1000 1500 2000 0 200 400 600 800 1000
Time Time

3


20000
1500
15000
1000
p1rv
p2rv
10000
500
5000
0
0
0 500 1000 1500 2000 0 200 400 600 800 1000
Time Time

0.08
0.06
0.10
0.04
0.02
0.05
r2rm
r1rm
0.00
-0.02
0.00
-0.04
-0.06
0 500 1000 1500 2000 0 200 400 600 800 1000
Time Time

4


0.15
0.04
0.03
0.10
r2rv
r1rv
0.02
0.05
0.01
0.00
0.00
0 500 1000 1500 2000 0 200 400 600 800 1000
Time Time

e) What is the definition of a stationary stochastic process? Do prices look like
stationary process? Why? Do returns look like a stationary process? Why?

Definition of a stationary stochastic process: In the mathematical sciences, a
stationary process is a stochastic process whose joint probability distribution does
not change when shifted in time or space. As a result, parameters such as the mean
and variance, if they exist, also do not change over time or position. As an example,
white noise is stationary.
From the observation of the graphs above, prices for both stocks are not stationary
process since the rolling mean is changing over time and rolling variance includes
several high values.
However, the rolling mean of return processes doesn’t appear any obvious trend
over time. But the big numbers in variance determine that return processes are not
stationary either.
f) Compute autocorrelation coefficients ρk for 1≤k≤5 for prices and returns series.
P1t
[,1]
[1,] 1.0000000
[2,] 0.9952586
[3,] 0.9905095
[4,] 0.9856203
[5,] 0.9807094
[6,] 0.9760011
5


P2t
[,1]
[1,] 1.0000000
[2,] 0.9808425
[3,] 0.9619482
[4,] 0.9441063
[5,] 0.9262671
[6,] 0.9107144
r1t
[,1]
[1,] 1.000000000
[2,] -0.003720422
[3,] 0.020920001
[4,] 0.015134049
[5,] -0.035417986
[6,] -0.063093877
r2t
[,1]
[1,] 1.000000000
[2,] -0.002964954
[3,] -0.012364290
[4,] 0.015955982
[5,] -0.024635205
[6,] -0.060960500
Series p1t Series p2t

1.0
1.0
0.8
0.8
0.6
0.6
ACF
ACF
0.4
0.4
0.2
0.2
0.0
0.0
0 1 2 3 4 5 0 1 2 3 4 5
Lag Lag

6


Series r2t
Series r1t
1.0
1.0
0.8
0.8
0.6
0.6
ACF
ACF
0.4
0.4
0.2
0.2
0.0
0.0
0 1 2 3 4 5 0 1 2 3 4 5
Lag Lag

g) Based on the computed autocorrelations for IBM and MSFT stock prices and returns,
what can you say about correlation between stock prices for different days? What
can you say about correlation between stock returns for different days?

From the graph in (f), we can see that the stock prices series are highly correlated,
since the correlation coefficients are very close to 1. So, the correlation between
stock prices for different days is very strong. But, the stock returns series are weakly
correlated, since the correlation coefficients are very close to 0. So, the correlation
between stock returns for different days is very weak.
h) Using your stock returns for IBM and MSFT, rit, i = 1, 2, construct four more series yit
= |rit|λ, i = 1, 2 and λ = 1, 2. Compute autocorrelation coefficients ρk for 1≤k≤5 for the
newly constructed series. Compare the computed correlations for |rit|λ, λ = 1, 2, and
|rit|. Are results as you expected?
7


Series absr1t Series absr2t
1.0
1.0
0.8
0.8
0.6
0.6
ACF
ACF
0.4
0.4
0.2
0.2
0.0
0.0
0 1 2 3 4 5 0 1 2 3 4 5
Lag Lag

Series absqr1t Series absqr2t
1.0
1.0
0.8
0.8
0.6
0.6
ACF
ACF
0.4
0.4
0.2
0.2
0.0
0.0
0 1 2 3 4 5 0 1 2 3 4 5
Lag Lag

The results are as expected.

i) Use the Jarque-‐Bera test (see Jarque and Bera (1980, 1987)) to test the assumption
of return normality for IBM and MSFT stock returns.

Jarque Bera Test

data: r1t
X-‐squared = 6966470, df = 2, p-‐value < 2.2e-‐16

Jarque Bera Test

data: r2t
X-‐squared = 77214.5, df = 2, p-‐value < 2.2e-‐16

8


2. Use R program to estimate the probability density function of standardized IBM and
MSFT stock returns.
(a) Estimate and construct a graph of the estimated probability density function for IBM
and MSFT stock returns.
0.6
0.4
0.2
0.0
-3 -2 -1 0 1 2 3
9


(b) On the same graph with the empirical density, construct a graph of the standard
normal density function. Comment your results.
0.6
0.4
0.2
0.0
-3 -2 -1 0 1 2 3
Compared to the standard normal distribution, which is the green curve in this
graph, the two empirical distributions have a higher peak and heavy-‐tail, which is
normal according to the textbook.
10


(c) Construct QQ-‐plot for standardized IBM and MSFT returns. You may use the R
command for this. Comment your results.
Normal Q-Q Plot
25
20
Sample Quantiles
15
10
5
0
-3 -2 -1 0 1 2 3
Theoretical Quantiles
Normal Q-Q Plot

10
8
6
Sample Quantiles
4
2
0
-2
-3 -2 -1 0 1 2 3
Theoretical Quantiles

According to the two QQplot graphs above, it’s only similar to standard normal
distribution from -‐2 to 1.5 for IBM stock return. And it’s -‐1.5 to 1.5 for MSFT stock
return.
11


R codes
Problem 1

library(fTrading)
library(tseries)
IBM=read.csv(file="/Users/brianzwb/Documents/Financial
Econometrics/IBM.csv",header=T,skip=1)
MSFT=read.csv(file="/Users/brianzwb/Documents/Financial
Econometrics/MSFT.csv",header=T,skip=1)
IBMprice=IBM[,5]
IBMreturn=diff(log(IBMprice))
MSFTprice=MSFT[,5]
MSFTreturn=diff(log(MSFTprice))
MSFTreturn
r1t=IBMreturn
r2t=MSFTreturn
dim(r1t)=c(4,length(r1t)/4)
monthly1=colSums(r1t)
r1t=IBMreturn
r2t=r2t[1:1136]
monthly2=colSums(r2t)
r2t=MSFTreturn
p1t=IBMprice
p2t=MSFTprice
ts.plot(p1t)
ts.plot(p2t)
ts.plot(r1t)
ts.plot(r2t)
p1rm=rollMean(p1t,13)
p1rv=rollVar(p1t,13)
p2rm=rollMean(p2t,13)
p2rv=rollVar(p2t,13)
r1rm=rollMean(r1t,13)
r1rv=rollVar(r1t,13)
r2rm=rollMean(r2t,13)
r2rv=rollVar(r2t,13)
ts.plot(p1rm)
ts.plot(p2rm)
ts.plot(p1rv)
ts.plot(p2rv)
ts.plot(t1rm)
12


ts.plot(r1rm)
ts.plot(r2rm)
ts.plot(r1rv)
ts.plot(r2rv)
acf(p1t,5)$acf
acf(p2t,5)$acf
acf(r1t,5)$acf
acf(r2t,5)$acf
absr1t=abs(r1t)
absr2t=abs(r2t)
absqr1t=r1t^2
absqr2t=r2t^2
acf(absr1t)$acf
acf(absr1t,5)$acf
acf(absr2t,5)$acf
acf(absqr1t,5)$acf
acf(absqr2t,5)$acf
jarque.bera.test(r1t)
jarque.bera.test(r2t)
Problem 2

d1={r1t-mean(r1t)}/sd(r1t)
d2={r2t-mean(r2t)}/sd(r2t)
x0=seq(-3,3,length=100)
y0=density(d1,n=100,from=-3,to=3)
y1=y0$y
qqnorm(d1)
qqline(d1,col=2)
y2=density(d2,n=100,from=-3,to=3)
y3=y2$y
qqnorm(d2)
qqline(d2,col=2)
matplot(x0,cbind(y1,y3),type="l",lty=1:3,xlab="",ylab="")
matplot(x0,cbind(y1,y3,dnorm(x0)),type="l",lty=c(1,2),xlab="",ylab="")
13

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Financial Econometrics Homework 1

1. Download weekly price data for IBM and Microsoft stock.

0 500 1000 1500 2000 0 200 400 600 800 1000

0 500 1000 1500 2000 0 200 400 600 800 1000

0 500 1000 1500 2000 0 200 400 600 800 1000

0 500 1000 1500 2000 0 200 400 600 800 1000

Series p1t Series p2t

Series absr1t Series absr2t

Normal Q-Q Plot

Normal Q-Q Plot

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