AC437 Financial Econometrics

This is another core module. The first part is taught together with the MSc Econ students, which covers classical econometric theory - linear regression, OLS, MME, MLE, GLS, IVE, hypothesis test framework, Wald, LR, LM, asymptotic theory. The second part focuses on applications to finance - random walk, event studies, CAPM, factor models, PV relations, volatility modelling, GMM.

The paper this morning was not too difficult, but I can kick myself now. I am embarassed to say that I got simple stuff wrong...calculation of power of a test! That's 10% gone! Shit happens. But I'm not the only duck, apparently many people got it wrong too. Other than that, I'll probably be penalised here and there for whatever reasons they might give. Hope I'll scrap through to get a distinction on this one, but not very confident either.

The next paper on Tue is gonna be a killer. The whole class is scared shit. And it happens to be the module I like most.

CAPM tests

Many tests have been carried out to determine if the CAPM holds. CAPM postulates that beta completely captures the cross-sectional variation of expected returns. Now, I am not convinced that this simple relationship can help to predict asset returns, and is evidenced by the many test results over the past few decades. Presence of irrational investors and other risk factors must be involved. Hence I wouldn't be interested in doing a test (but which I did several years back). What is surprising is the paper by Fama & French (1992, 1993), that including book-to-market and size as factors can in fact explain asset return variation better. It is also quite robust to different time periods. So much so as this is taken as the industry benchmark in comparing investment portfolios. But how do we intepret BM and size as risk factors? And are there other missing factors?