DAFN – 2018, Term 7, Group HW 1

-- (due Monday, Jan 29 by 11:59 PM IST)

Multivariate Simulation

Prepare a five-year time series of monthly price data from Dec 2012 through Dec 2017 for each
of the following ticker symbols: KO, ^GSPC (i.e., Coca Cola and the S&P500 index,
respectively). Be sure to submit your code along with your answers to the questions below.
Please organize your code so that it is easy to follow and so that it is clear which question/portion
the code is designed to address. Be sure to include comments where appropriate.

To start, estimate a regression of excess KO returns on excess market returns:

§ !! =∝ +! ∙ !!,! + !! (Eq. 1)
For simplicity, you can just assume that the riskless rate rf = 0 throughout our sample period, and
simply estimate a regression of stock returns on market returns. Use returns on the S&P 500
index (^GSPC) to proxy market returns.
Ø Q1. Create a table of key information for your results.
Ø Q2. What can you say about the alpha of KO during this time frame?
Ø Q3. Identify and explain any statistical assumptions you’ve made.

Now using coefficient estimate ! and residual vector ! from this first pass, simulate 10,000
∗
return paths for KO under the null hypothesis of ! = 0. That is: !!"#,! = ! ∙ !!,! + !!"#,! where
∗
each !!"#,! is drawn, with replacement and with equal probability, from residual vector !. That
∗
is, !!"#,! ~!"#(!) where !"#(!) represents the empirical distribution function that assigns
equal probability, 1/T, to each !! in residual vector !.1
Ø Q4. Present in a single plot: (i) the actual time series of KO stock returns; (ii) the average
simulated KO returns (across all 10,000 simulations) over time; and (iii) the 5th and 95th
percentiles of simulated KO returns over time.

Now using your simulated returns, re-estimate the previous regression across all 10,000
simulations: !!"#,! = ! + ! ∙ !!,! + !!
Ø Q5. Create a table conveying the key information from your simulations. For instance,
what is the average ! and ! across all simulations? And how often do you get statistically
significant alphas?
Ø Q6. In building our simulated return series above, why did we omit ! ?

1
Just a technical FYI: to be precise, we should actually scale the residual vector by a factor of [T / (T -2)]½, because
the empirical distribution of the residuals from equation (1) has variance T-1Σ εˆ t2 = T-1(T – 2)ŝ2, in which ŝ2 is the
unbiased estimator of σε2.