Economics Homework Help

4. DiscussionUsing your web browser and your own judgement and your class notes, please interpret and discuss the strength of the relationship between stock price returns for your firm and each of the three variables. In particular, please consider whether or not you think that the three variables do a good job in explaining and predicting stock returns for your firm. Please also explain why you think the model produced all results from questions 2 and 3 that it did. 

To begin, we discuss question #4. There are three aspects of question 4; statistics, economics and managerial. First, for statistics, please take a look at what you found in questions 2 and 3 to be statistically significant and important in explaining the return for your firm (the key statistical information here is the adjusted R-squared, p-value, model f-value all of which you summarized in your response to 2c and 2d). Then, and using the economic interpretations for these variables only (please note: the economic interpretations are provided below), please perform an Internet-based research using your web browser to provide an explanation regarding why these explanatory variables were able to explain the return for your firm. This is the managerial aspect.

The economics aspect depends upon the economic interpretations which are:

EXMRKT is related to the S&P 500 or a similar large scale stock market index and so it correlates with a diversified group of companies and so its tied to the performance of many firms and thus the well being of many people and it correlates to generally to income of country or business cycles (at up point in a business cycle, market does better economy does better and this tends to be correlated to people having higher income). So, we want to assess how realty income performs in different states (or business cycles) of the overall economy.

The SMB factor is measured using the market capitalization and represents return to portfolios formed on size measured as market cap, this is what SMB means small minus big. So, if the portfolios are formed by placing companies into buckets or groups defined by deciles (i.e., bottom 10percent, next bottom 10 percent, bottom 30 percent, etc.) then the return on the smallest 10 percent or bottom decile minus the return on the biggest 10 percent or top decile computed at each date point is the SMB factor. Thus, a reduction in this value would be a consequence of the return on the bigger firms being greater than the return on the smaller firms. A bigger firm would then see a negative sign since it would say higher SMB (implying higher return on small firms relative to big firms) would lead to lower (relatively) return for the bigger firm and vice versa for a small firm. This is measuring size using market capitalization of your company, realty income, to see where it fits in this horizon.

HML is constructed in a similar manner except in regards to book to market ratio and so as we mentioned very early in semester (maybe week 2 or 3), we are looking at High book to market ratio is meaning the old or historical (accounting or book) value being large relative to current (today’s) value and so here we say this is sign of low growth in the firm, but a low book to market means the old or historical value is low relative to today’s value and so the firm is assumed to have grown more. So, HML is related to growth opportunities for realty income.

The second purpose of this email is to let you know what to include in your final writeup. For question #1, please include the steps you used to collect all the data on the three fama french factors along with the definitions of these three variables and also your stock price data as well as how you converted the stock price to the stock price return. These steps have been sent in an email through the Canvas site and the definitions are provided on the WRDS site itself. For question #2 (part a, b, and c), please include the summary output charts and the estimated line fit plots produced by excel when you carried out the regressions. For question #2 (part b), please include the summary output chart and the corresponding fitted equation. Please include the same things in your response to question #3a. Please also remember to include all the details regarding how you carried out your regressions and any calculations that you made (including for instance in question 3b). Finally, I prefer that you copy and paste all of these into your Microsoft word document. The final writeup typically is on the order of 5-10 pages and for most people it turns out to be about 8 pages. But, there is no specific page limit, I do prefer quality over quantity and give you this page range in order to help you to manage all the documents and what needs to be turned in.