Econometric analysis of nancial data

Anish Shankar Menon

March 10, 2014
Abstract
This paper tries to analyze nancial time series data using various
econometric techniques.
1 Data Description
The study looks at 2 data series. The series are the National Stock Exchange
(NSE) Nifty Index and the Nifty Junior index. The period of study is for 10
years from 01/01/2004 to 31/12/2013. There are 2493 observation per series
totalling to 4986 data points The software packages Stata 11 and Eviews 6
have been used to analyze the data.
2 Descriptive Statistics
The following table gives the descriptive statistics of the raw data.
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Particulars Nifty Junior Nifty
Mean 4241.702 8168.192
Median 4676.950 8597.700
Maximum 6363.900 13555.15
Minimum 1388.750 2685.100
Standard Deviation 1435.469 3026.478
Skewness -0.468699 -0.189799
Kurtosis 1.870381 1.669637
Jarque Bera 223.8249 198.8127
Probability 0.000000 0.000000
Both the indices are negatively skewed and have high volatility. The line
graphs show a general upward trend with two signcant drops, one in the
period 2008-09 and the second around the year 2012. The Junior Nifty seems
to be more volatile than the Nifty.
3 Stationarity tests
3.1 Testing for unit root in the raw data
The corellogram of both data series show that the series are non-stationary.
The following set of tables presents the results of the stationarity tests
on the raw data (levels):-
The Augmented Dickey Fuller (ADF) Test for a unit root
The null hypothesis is that there is a unit root (the series is non station-
ary)
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Series p values
Nifty 0.6149
Nifty Junior 0.6426
The Kwiatkowski-Phillips-Schmidt-Shin (KPSS) test of station-
arity
The null hypothesis is that the series is stationary.
Series p values
Nifty 0.0000
Nifty Junior 0.0000
From both the ADF and KPSS tests it can be concluded that the series
are non-stationary.
3.2 Transformation of data
In order to make the series stationary, the data has been converted to its
natural log and the rst dierence has been taken.
The line graphs of the transformed series and the correlograms show that
the series now seem to be stationary. No trend can be discerned from the
line graphs.
4 Testing for unit root in tranformed data
The Augmented Dickey Fuller (ADF) Test for a unit root
The null hypothesis is that there is a unit root (the series is non station-
ary)
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Series p values
Nifty 0.0001
Nifty Junior 0.0000
The Kwiatkowski-Phillips-Schmidt-Shin (KPSS) test of station-
arity
The null hypothesis is that the series is stationary.
Series p values
Nifty 0.1466
Nifty Junior 0.1432
It can be observed that both the series are now stationary i.e., there is
no unit root.
5 Autoregressive/Moving average models
Once the data is stationary, the univariate series could be modelled.
In order to study the process, the correlogram is used.
From the autocorrelation and partial autocorrelation plots, it is not pos-
sible to comment on the choice of the model nor the lag-length. The process
is neither pure autoregressive (AR) or a moving average (MA.).
Therefore the only way is to use the Akaike Information Criterion (AIC),
Hannan Quinn Information Criterion (HQIC) or the Schwarz Bayesian Infor-
mation Criterion. The model which gives the lowest value of the criterion will
be chosen. It is important to remember that the data has been dierenced
already.
The model that t the best for the Nifty returns series was an ARMA(2,2)
model. An ARMA process is one where the current value of some series de-
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pends linearly on its own past values plus a combination of current and pre-
vious values of a white noise error term. The results show that the two lags
of both the AR process and the MA process are signicant. An ARMA(3,3)
model was also signicant but the ARMA(2,2) was better based on the in-
formation criterion.
In the case of the Nifty Junior returns series, an ARMA(1,2) showed best
t. The MA(2) coecient however is signicant at 10% only.
6 Vector Autoregression
Vector Autoregression (VAR) is a systems regression model. All variables in
a VAR model are endogenous.
The lag length was selected using the information criterion. The model
was run with lag lengths of 1, 2 and 3. It was observed that the rst lag with
Nifty returns as the independent variable and the Junior Nifty returns as the
dependent variable was signicant and not vice-versa. It can be inferred that
the Junior Nifty can be predicted using the lagged values of the Nifty or that
the Nifty leads the Junior Nifty.
The strange behavior however is that the lag of the Junior Nifty returns
does not explain itself i.e., the coecient of its own lags are not statistically
signicant.
The residuals have been tested for serial correlation in the VAR model
with two lags. It is seen from the VAR Lagrange Multiplier (LM) test that
there is serial correlation in the residuals.
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7 Impulse response
The impulse response tests the responsiveness of the dependent variables in
the VAR to shocks in each of the other variables. A unit shock is applied to
the error and the eects on the VAR are noted over time.
It is observed that the shocks die down after a short period of time. The
VAR result is conrmed by the impulse response graphs as there is an impact
on the Junior Nifty when a shock is given to the Nifty.
8 Granger Causality
The Granger causality test is performed in a VAR framework. The VAR
model as specied above is run.
The VAR Granger Causality/Block Exogeneity Wald Tests have been
used to determine Granger causality. It shows that the Nifty series seems to
Granger cause the Junior Nifty series.
Granger causality does not imply causality in the true sense. It simply
implies a chronological ordering of the series. Hence the Nifty returns series
seems to lead the Junior Nifty returns series.
9 Cointegration
The cointegration is done when there is a presence of unit root. It shows the
long term relationship between time series. In this study, the raw series are
used. Cointegration is tested using the Johanssen approach.
The tests suggest that there is 1 cointegrating relationship between the
two series. The relationship shows a quadratic trend. The equation has a
trend and intercept. The VAR however has a linear trend.
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10 Modelling volatility
Financial data have some peculiar characteristics. This include leptkurtosis
(fat tails), volatility clustering and leverage eects (a large rise in volatil-
ity following a rise in price and a small fall for a fall in price of the same
magnitude). In order to model these characteristics various non-linear mod-
els are used. Popular among these are the Autoregressive Conditional Het-
eroscedasticity (ARCH) model, the Generalized ARCH (GARCH) model and
the Exponential GARCH (EGARCH) model.
The GARCH model is parsimonious and avoids overtting. Firstly the
series was tested for ARCH eects. It was found that both the series had
ARCH eects at 1 lag. The GARCH model was then tted to tha data. It
is observed that coecients on both the lagged squared residual and lagged
conditional variance terms in the conditional variance equation are highly
statistically signicant. The sum of the coecients on the lagged squared
residual and the lagged conditional variance of the Nifty and the Junior Nifty
returns series is close to unity, dominated by the coecient of the conditional
variance.
In both models, the coecients are positive. Therefore there is no risk of
forecasting negative variance.
11 Conclusion
This paper looks at two dierent nancial time series and tries to analyze
them and help build models for forecasting.
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