Advanced Regression Computer Problem 2

You wish to investigate whether some foreign stock market depends on past daily movements in the U.S. stock market, accounting for possible day-of-the-week effects.

1. Daily data for the U.S., Japan, and 3 other countries’ stock market indexes are available on the O: drive, for five years between 1997 and 2002.

2. Specify the following model:

Rjt = [a1d1 + a2d2 + a3d3 + a4d4 + a5d5] + b1 Trendt + c1 RUSt-1 + c2 RUSt-2 + c3 RUSt-3 + c4 RUSt-4 + c5 RUSt-5 + εt where d1 = 1 if Monday, 0 otherwise; d2 = 1 if Tuesday, 0 otherwise; … Trendt = time trend (values index the observations, from 1 to T); Rjt = stock return on day t for Japan; RUSt = stock return on day t for US.

3. Test the following hypotheses for the Japanese stock market: H1: b1 = 0; H2: c1 = .25; H3: c1 + c2 + c3 + c4 + c5 = .5; H4: H2 and H3; H5: H1, H2, and H3; H6: a1 = a2 = a3 = a4 = a5. H7: Chow Test - coefficients are identical before & after market crash on March 1, 2000.

Hint: You must figure out how to impose each of these restrictions, to get SSER. For example, consider the restricted model for H3. Under H3, c5 = .5 - c1 - c2 - c3 - c4. Substituting this into the unrestricted model yields the restricted model appropriate for testing H3:

Rjt = [a1d1 + a2d2 + a3d3 + a4d4 + a5d5] + b1 Trendt + c1 RUSt-1 + c2 RUSt-2 + c3 RUSt-3 + c4 RUSt-4 + (.5 – c1 – c2 – c3 – c4.) RUSt-5 + εt

Simplifying: (Rjt - .5RUSt-5) = [a1d1 + a2d2 + a3d3 + a4d4 + a5d5] + b1 Trendt + c1 (RUSt-1 - RUst-5) + c2 (RUSt-2 - RUst-5) + c3 (RUSt-3 - RUst-5) + c4 (RUSt-4 - RUst-5) + εt

Run this regression model. Its SSE is the SSER appropriate to construct the F-test for H3.

4. Test H1-H6 for at least one other foreign stock market besides Japan.