(5/5)

Question 1 (25 marks)

You are given the data set “macro_variables”. The file contains the following variables:

i) dcredit: unexpected change in consumer credit

ii) dinflation: unexpected change in the inflation rate

iii) dmoney: unexpected change in money supply

iv) dprod:unexpected change in industrial production

v) dpsread: unexpected change in credit spreads

vi) ermsoft: risk premium over Microsoft stock

vii) ersandp: risk premium over market portfolio (SandP)

viii) rterm:unexpected change in the term structure

You are to answer the following questions:

a) Run a Multiple Linear Regression Model with the variable “ermsoft” as the dependent variable and all other variables as the independent variables. Show the EViews output and interpret ALL the variables. (3 marks)

b) Which variables are significant and which variables are insignificant? Why? (3 marks)

c) Is the entire model significant? Why? (3 marks)

d) Which tests are being used in c) and d), respectively? (3 marks)

e) What is Heteroscedasticity? (3 marks)

f) Check for Heteroscedasticity. Show output! (3 marks)

g) Run a model with Robust Standard Errors. Show output! (4 marks)

h) Why is step g) important? (3 marks)

Question 2 (20 marks)

Using the same dataset, consider the following:

The structural equations are as follows:

〖inflation〗_t=α_0+α_1 〖returns〗_t+α_2 〖dcredit〗_t+α_3 〖dprod〗_t+α_4 〖dmoney〗_t+u_1t

〖returns〗_t=β_0+β_1 〖dprod〗_t+β_2 〖dspread〗_t+β_3 〖inflation〗_t+β_4 〖rterm〗_t+u_2t

returns are stock returns (rsandp).

It is evident that there is feedback between the two equations since the inflation variable appears in the stock returns equation and vice versa.

Therefore, since the above equations suffer from simultaneity the reduced-form equations are:

inflation=f(constant,dprod,dspread,rterm,dcredit,dmoney)

returns=f(constant,dprod,dspread,rterm,dcredit,dmoney)

a) Use Two-Stage Least Squares to estimate each of the reduced-form equations. Show output! (10 marks)

b) Conduct the Hausman Test for the endogeneity of Stock Returns and Inflation. Show output! (10 marks)

(5/5)

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