Financial Econometrics
Undergraduate Programmes 2020/21


Retrieve from the excel file “Datafile_for_Part_A.xls” on DUO your individual datasets
corresponding to your student ID number.
Suppose you are a bank analyst tasked with predicting defaults on bank loans. You
are given a dataset consisting of:
D: default (0 for repayment, 1 for default).
Loan characteristics:
A: amount requested.
R: duration in months.
I: interest rate on the loan.
Applicant characteristics:
L: duration of employment.
Y: income.
H: home ownership (0 for rent, 1 bought).

1. Estimate LPM, probit, and logit models for predicting default based on all other
variables. Describe your findings.
(10 marks)
2. Using each model, compute the change in the likelihood of default associated with
a 10% increase in the size of the loan. Explain how you arrived at this estimate.
(10 marks)
3. Use each model to predicts default. Evaluate the accuracy of each model.
(10 marks)

Part B:
Download the data file “investment.txt” from DUO. The file contains data on real gross
investment, I, the real value of the firm in terms of shares outstanding, F, and the real
value of the capital stock, C, for a panel of large US manufacturing firms.
1. Estimate a model for predicting I in terms of F and C without fixed effects, with entity
fixed effects only, and with both entity and time fixed effects. Describe your findings.
(10 marks)
Financial Econometrics
Undergraduate Programmes 2020/21


2. Why might it be a mistake to interpret the coefficients as causal effects? How would
you remedy this problem?
(10 marks)

Obtain 10 years or more of daily time series of spot and futures prices for one financial
asset from DataStream (these could be a stock index, interest rate, exchange rate,
commodity, or any other financial asset). Using the spot and futures prices, construct
the time series of the futures contract basis risk or Basis (Basis is the spread between
the spot and futures prices).
To summarise the data:
• Provide the names of the spot and futures contracts you have chosen to hold
in your portfolio, with their DataStream IDs.
• In the Appendix, plot the time series of your spot prices, futures prices and the
time series of the Basis.

Answer ALL of the following questions:
1. Choose an in-sample period and estimate the best-fit time series model for the
mean and variance process for your Basis. Carefully discuss the procedure you
have adopted to obtain the best model and interpret your results. You can
compare your modelling results with relevant academic research articles.
(20 marks)
2. Perform out-of-sample forecasting of your Basis:
o Using the best mean and variance model specifications obtained from Question
1, forecast the mean and the variance process.
o Explain how you have produced the out-of-sample mean and variance
forecasts and what assumptions you have made.
o As an illustration, show mathematically how the forecasts are calculated for a
few steps ahead and compare it with the forecasts generated by Eviews.
(20 marks)

Financial Econometrics
Undergraduate Programmes 2020/21


3. Evaluate the forecast performance of your best mean and variance model against
a naïve benchmark model (such as the random walk). Use appropriate forecast
evaluation measures to assess the accuracy of your mean and variance forecasts.
Interpret the significance of your results from the perspective of a portfolio
manager who holds the futures contract.
(10 marks)

Overall word limit: 4500


Your completed assignment must be uploaded to DUO
no later than 12:00 midday on 29 April 2021

A penalty will be applied for work uploaded after 12:00 midday as detailed in
the Programme Handbook. You must leave sufficient time to fully complete
the upload process before the deadline and check that you have received a
receipt. At peak periods, it can take up to 30 minutes for a receipt to be

Assignments should be typed, using 1.5 spacing and an easy-to-read 12-point font.
Assignments and dissertations/business projects must not exceed the word count
indicated in the module handbook/assessment brief.
The word count should:
▪ Include all the text, including title, preface, introduction, in-text citations, quotations,
footnotes and any other items not specifically excluded below.
▪ Exclude diagrams, tables (including tables/lists of contents and figures), equations,
executive summary/abstract, acknowledgements, declaration, bibliography/list of
references and appendices. However, it is not appropriate to use diagrams or
tables merely as a way of circumventing the word limit. If a student uses a table or
Financial Econometrics
Undergraduate Programmes 2020/21


figure as a means of presenting his/her own words, then this is included in the word
Examiners will stop reading once the word limit has been reached, and work beyond
this point will not be assessed. Checks of word counts will be carried out on submitted
work, including any assignments or dissertations/business projects that appear to be
clearly over-length. Checks may take place manually and/or with the aid of the word
count provided via an electronic submission. Where a student has intentionally
misrepresented their word count, the School may treat this as an offence under
Section IV of the General Regulations of the University. Extreme cases may be viewed
as dishonest practice under Section IV, 5 (a) (x) of the General Regulations.
Very occasionally it may be appropriate to present, in an appendix, material which
does not properly belong in the main body of the assessment but which some students
wish to provide for the sake of completeness. Any appendices will not have a role in
the assessment - examiners are under no obligation to read appendices and they do
not form part of the word count. Material that students wish to be assessed should
always be included in the main body of the text.
Guidance on referencing can be found in the programme handbook and on DUO.

Performance in the summative assessment for this module is judged against the
following criteria:
• Relevance to question(s)
• Organisation, structure and presentation
• Depth of understanding
• Analysis and discussion
• Use of sources and referencing
• Overall conclusions

Students suspected of plagiarism, either of published work or the work of other
students, or of collusion will be dealt with according to School and University