2020 Nov ECON339 Spring Session/T3 Wollongong/PSB Academy Page 2 of 3 Section A. Answer all questions. (15 marks, 1 mark each) 1. Violating which of the classical linear regression model assumption will lead to a biased OLS estimator? [1]
2. In a system of equations given below, Y’s are endogenous while X’s are exogenous. Which of the equation is just identified? Explain. [2]
3. State one advantage of using a Vector Autoregression (VAR) model. [1]
4. In the following VAR model, write down the null hypothesis for the Granger causality test of ݕଶdoes not Granger cause ݕଵ? [1]
5. In a VAR model, name the method of analysing the proportion of the movements in the dependent variables that are due to their “own” shocks, versus shocks to the other variables. [1] Section B.
Answer ALL questions (35 marks) Question B1 (20 marks)
In the paper on the “Overreaction Hypothesis and the UK Stock Market” by Clare and Thomas (1995), the authors employed monthly UK stock returns from January 1955 to December 1990 on all firms traded on the London Stock exchange to run a regression ttDeR, (B1-1) where WtpLtptDRRR, Rdenotes the monthly average excess return over the stock market and tdenotes the 18 independent tracking periods. LtpR, and WtpR, are the loser’s and winner’s portfolio returns respectively.
(a)State the overreaction hypothesis and how can one use regression (B1-1) to test for the overreaction hypothesis? [2]
(b) Suppose the loser stocks are generally more risky, explain the drawback of using regression (B1-1) when testing the overreaction hypothesis. How would you correct for it?
[2] Using the data employed by Clare and Thomas (1995), suppose you are interested in analyzing whether there are quarterly return differences between the loser and winner portfolios. You estimated the following regression by OLS: tttttDeQQQR,33,22,11, (B1-2)
