Market model is a term used in finance to describe a linear regression model in

Question

Market model is a term used in finance to describe a linear regression model in which the dependent variable is the return on a stock and the predictor variable is the return on the overall market. The market model is sometimes extended to include other predictor variables-for example, the return on a specific industry sector Company A is one of the leading software companies in the world. Imagine an analyst in an investment bank is creating a market model to predict returns on Company A stock from both market and industry returns. The multiple regression model is: where ydaily returns for Company A stock X1daily returns for the Dow Jones Industrial Average X2 daily returns for the NASDAQ Computer Index Returns for the Dow Jones Industrial Average (DJIA) will indicate market returns, while those for the NASDAQ Computer Index (NCI) will indicate industry returns. The analyst estimates the parameters 0, 1, and 2 using daily returns for the period January 3, 2005, through December 30, 2005. The estimated multiple regression equation is: y = 0.0008 + 0.6404X1 + 0.6869X2

Explanation / Answer

1)

y^   = 0.0008 +0.6404 * x1 + 0.6869 *x2

= 0.0008 +0.6404 * 0.01 + 0.6869 *0.02

=0.020942

= 2.094%

Thus, the estimated average returns on A is 2.094% or 2.09 % upto 2 decimal places. The point estimated value will be same for both the average returns on all days and for one particular day; only the variance of the prediction of a single day is greater that that of average estimate of all days. Hence, the Company A stock return on a specific trading day is also 2.094% The predicted return has value equal to the average value.

2)

95 % confidence interval is 0.26 % to 3.93%

95% prediction interval is -9.61 % to 13.8%

3)

. The interval for average stock A return is narrower than that for predicted stock return. This is because we can estimated average return with greater precision, and hence the spread is minimum.

4)

95% prediction interval

= (36156,45520)

Related Questions

Navigate

• Browse (All)
• Browse M
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.