magine that you are at 3 years from now. You have a stable and well-paid job, so you are thinking about investing part of your money. You do not have time to take care of a new business,
e.g., owning a restaurant or coffee shop, so you limit your attention to financial assets. You find U.S. stock market might be a good place to go. You would like to understand how good the U.S. stock market is. In particular, you want to know how lucrative and how safe it is for you who has not dealt with stock before.
You start with collecting the historical data of stocks. Center of Research for Security and Price (CRSP) has all the security related information (download ‘CRSP_2021.csv’ from Canvas under section “Data and other Resources”), and you start your investigation.
PERMNO and Ticker are unique firms’ identifications. Date is the month-end date (yyyymmdd), and the stock price (PRC) is measured at the end of that date. Monthly return (RET) is the stock return measured from the last month-end date to the current date.
Since we are interested in publicly tradable common shares, we only consider firms with SHRCD equal to 10 and 11. There are many stock exchanges in U.S., while we consider only the biggest three, NYSE, AMEX, and Nasdaq, with PRIMEXCH N, A, and Q respectively as they are most liquid, that is, you can buy and sell with ease.
The firms’ market equity (or market cap or size) is defined as the stock price per share (PRC) times total number of shares (SHROUT). However, please note that PRC contains negative values because if the stock was not traded for a while before the month-end, CRSP records some alternative price measures and puts a negative sign in the front. Therefore, you have to take the absolute value of PRC before times it with SHROUT.
1. Descriptive analysis:
What is the starting and ending month of the sample period? Show the Tickers and other information for largest (market cap) 10 firms by the end of the sample? If you find both
“GOOG” and “GOOGL”, do not be surprised. That is because google has double-class shares.
2. Since you do not have superior information relative to others, especially the financial institutions, you plan to invest in a broad market index which contains all stocks traded (after screening for SHRCD and PRIMEXCH). Calculate the monthly equal-weighted average return from the beginning to the end of the sample period. (Please define the variable name as “RET.ew”) Note that some stocks have missing RET data in some months. That is probably because they are suspended from trading for a few months. Let’s take missing RET as zero and then calculate the equal-weighted average monthly returns. If you are using R, print out the result.
3. Probably a more interesting return measure is the value-weighted monthly returns, that is, you take a weighted average of the firm returns in each month and the weights are the firms’ last month’s market equity (call it ME). So, you lag the market equity for one month for all firms (call it ME.lag). Note that you need to lag market equity for each firm, not lag the entire column. If you are using R, print out the generated column.
4. Take the value-weighted average of monthly returns (call it RET.vw). We may have not covered this in the class, but it is simple. Search “weighted average in Excel (or R)” in Google, you will find the function and how to use it. In addition, please note that ME.lag may contain missing values, let’s exclude the firms with missing ME.lag. If you are using R, print out the result.
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