PROJECT 3: MULTI-FACTOR MODEL OF STOCK PRICES
Objectives:
1. Estimate and interpret whether a basic five factor model is reliable as a means of
evaluating whether a stock is over or underpriced.
2. Use a measure of model stability to test whether all relevant factors have been included in
the model.
Estimation Instructions
1. Collect stock price data, long and short term Treasury interest rate data and data on
long corporate bond rates (rated A) for the period over which you intend to test the
model. Convert the stock price data into daily rates of return (in percent). Convert
interest rate data into daily rates (divide by 365). Compute the Treasury long-short
spread and the credit spread (Corporate rate minus Treasury rate of same maturity).
2. Combine with data on the French-Fama factors provided in the Daily French Fama
Factors EXCEL file available on Sakai. Subtract the risk-free rate from the daily
return on stock price to create the dependent variable.
3. Estimate three models. One is over the entire sample period. Two are over two
subperiods. These are your ‘before’ and ‘after’ cases.
4. Perform a Chow test to test the hypothesis that estimated regression coefficients are
significantly different in the subperiods compared to estimated coefficients for the
entire period. See a sample Chow test in the Fama French Demo BUT ADJUST k = 6
since this is a 5 factor model. There is a related reading (Chow test example). Both are
posted on Sakai
Writing Instructions
1. Explain why you chose the sample period and over what event you are testing the
model’s stability.
2. In all three models discuss whether the intercept and slope coefficients are significantly
different from zero and what data leads to that conclusion.
3. Show your calculation for the Chow test and interpret your result. Include the cutoff
value for the F statistic (Find an F table in a statistics text or on the Internet if necessary.
Use 5% as the confidence level). Was your model stable over the event in question
according to this test? Is it reliable based on this test?
Include a sample of your data, and the printout of all three estimations as well as the
calculation of the Chow test statistic. Please, no electronic submissions!