# Length: 10 pages maximum (1.5 line spacing, Font Times New Roman 1...

## Question

Length:
10 pages maximum (1.5 line spacing, Font Times New Roman 12), with a maximum of 10 pages of appendices (including other tables and figures if necessary) Tables and figures must be clearly referenced throughout the main text. Tables and figures must be self-content and well-presented. Please avoid bullet points without complete sentences.

Subject
Q1. Discuss the suitability of the Fama-French model as a way to explain the excess returns of the given stock. Pay special attention to the interpretation of the regression output and the diagnostic tests as conducted in class and in the tutorials. How does this model perform relatively to the 1-factor model? (60 marks)

Q2. An investor is interested in finding a suitable model to forecast the financial risk embedded in the evolution of the stock volatility. Could you help him? Hint: visually check the properties of stock market returns and estimate the models discussed in the second half of the lectures that seem to account for the stylized facts observed in the data. Discuss the differences between these models and chose the one that you would propose
to the investor. (40 marks)

## Solution Preview

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Question 1: Fama French Model for estimating excess returns on the Coca-Cola stock:

There are various assumptions of checking whether the Fama French model can be applied to the given stock of Coca-cola for the years January 1990 to December 2009. We have nearly 20 years of data and other models such as the moving averages, time series data, ARMA model can be applied to predict the forecasts on excess returns. But we are asked whether Fama-French model could be applied to the same to find an model that would be able to predict the forecast for future months of the stock. For doing this we have to check for the assumptions and find whether they are not being violated in order to apply the ordinary least squares function of excel and predict the model.
What is Fama French model and why is it superior to other models?

CAPM is the single factor model which uses the excess returns of the portfolio, with the market volatility. This would give the result where the stocks with higher volatility in relation to the market would have lower prices and also would have higher expected returns. But generally the investors are concerned about various types of risk factors in the stock market rather than just one and these risks include the market risks and in addition to this, they have priced risks which include the size premium and the value...

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