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Forecasting in economic modelling
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5. DATA SOURCES, METHODOLOGY AND VARIABLE CONSTRUCTION
5.1. Return Calculation
There are two ways to calculate stock returns
5.1.1. Continuous Return
This is the percentage return that would be earned by an investor who bought the stock at the end of a particular day/month t-1 and sold it at the end of the following day/month. For day t and stock A, the day return R At is defined as
R At = { In (P At/P A, t-1)}*100
The stock paid a dividend in day t, the total return would be
R At = {In (P At +Divt /P A, t-1)}*100
5.1.2. Discrete Return
An alternative method to calculate stock returns is defined as
R At = {(P At/P A, t-1)-1}*100
5.1.3. Continuous Compounded versus Discrete Returns
Using continuously compounded rate of return, it is assumed that Pt = Pt-1 ert where rt is the rate of return during the period (t-1,t) and where Pt is the price at time t. If r1, r2,….,r12 are the returns for12 months, then the price of the stock at the end of the 12 months will be
P12 = P0 e r1 +r2 +….+r12
This representation of prices and returns allows to assume the average daily or monthly returns is r = (r1, r2,….,r12)/ 12.Since we can assume that the return data for the 12 months represent the distribution of the returns for the coming month, it follows that the continuously compounded return is the appropriate return measure, and not discretely compounded return. (Benninga, 2008)
5.2. TESTS OF RETURN PREDICTABILITY
In this research study, methodology consists of four sections based on information set of return predictability. Information set can be defined as the past history of stock prices, time patterns, market characteristics and firm characteristics .The first section consists of short-term return predictability based on past hi...
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...r ARIMA model, the next step is to see whether the selected model is appropriate. One test of the chosen model is to see if the estimated residuals from the model are white noise thereby the chosen model fits the data reasonably well. Box and Jenkins(BJ) methodology suggests some diagnostic checks to determine whether an estimated model is statistically appropriate or not; if “Yes” then go for the last stage i.e. forecast; if “Not” then go back for the first stage and repeat the procedure from identification and estimation of parameters to diagnostic checking until there is a good final model.
5.2.2.2.1. D) Stage 4: Forecasting
One of the reasons of the widely accepted ARIMA models is its success in forecasting. The forecasting made by this method is more authentic than those made from other econometric models particularly for short run forecasts (Gujarati, 2003).
The Smith & Wesson Holding Corporation stock has an EPS of 1.42 and a P/E ratio of 10.52. Upon running a regression, a coefficient of 0.139 was calculated. This means that if the SWHC stock increases by 1%, the S&P 500 stock will increase by 0.139%.When compared against the S&P 500 index, the SWHC stock has a correlation of 16.3%. This is relatively low. The SWHC stock can explain approximately 16.3% of the variation in the S&P 500. In other words, the stock does not behave the same as the S&P 500 and should not be used to predict the S&P 500. There is about 83.7% of the...
Moreover, the numbers of Monsanto last year were quite solid and since the first offer of Bayer, the price per stock rose more than 10 US Dollar. Using the news of the possible deal between Bayer and Monsanto, I believe that the expected price for the end of the month could be 107 US Dollar per share, what means that the annualized holding period is
Short-term corporate profitability: Residual income growth; sales growth; return on equity; percentage of sales from new products.
When determining whether to merge or partnership with another hospital is a beneficial choice, one will need to review financial information to make an informed decision. According to Cleverly, Cleverly, and Song in order to make effective decision it requires adequate knowledge and interpretation of financial information. Understanding the accounting processes of business decisions results in effective operational decisions (2012). Some of the financial statements that are used to make these decisions are income, itemized, balance statements, net assets, and cash flow.
The next model is the Quadratic Trend Model. The quadratic formula uses the least-squares method to forecast and can be written as Yi =b_0+ b_1 X_1+ b_2 X_2. In this formula the only difference is b_2 X_2 represents the estimated quadratic effect on Y. Figure 1-6 represents the comparison between the linear and quadratic
The Damon Investment Company manages a mutual fund composed mostly of speculative stocks. You recently saw an ad claiming that investments in the funds have been earning a rate of return of 21%. This rate seemed quite high so you called a friend who works for one of Damon’s competitors. The friend told you that the 21% return figure was determined by dividing the two-year appreciation on investments in the fund by the average investment. In other words, $100 invested in the fund two years ago would have grown to $121 ($21 ÷ $100 = 21%).
i.e. a. Fama, Eugene F. “Market Efficiency, Long-Term Returns, and Behavioral Finance.” Journal of Financial Economics 49, no. 1 (September 2011). 3 (1998): 283–306. i.e. a. Daniel K., Hirshleifer D. & Subrahmanyam A. 1998. The.
The concept of beta has gained prominence due to the pioneering works of Sharpe (1963), Lintner (1965) and Mossin (1966). There are many studies that examine the behaviour and nature of beta. These studies include the impact of the length of the estimation interval, the stability of individual security beta as compared to portfolio beta, factors influencing the beta as well as the stability of beta in various market conditions.
In turn everything in the present and the future is judged through the stocks as they hold a high importance in industrialized economies showing the healthiness of said countries economy. As investing discourages consumer spending over all decreases, it lead...
Capital Asset Pricing Model (CAPM) is an ex ante concept, which is built on the portfolio theory established by Markowitz (Bhatnagar and Ramlogan 2012). It enhances the understanding of elements of asset prices, specifically the linear relationship between risk and expected return (Perold 2004). The direct correlation between risk and return is well defined by the security market line (SML), where market risk of an asset is associated with the return and risk of the market along with the risk free rate to estimate expected return on an asset (Watson and Head 1998 cited in Laubscher 2002).
In the paper published by Xiong (2010), it is presented that a portfolio’s total return can be disintegrated into three components: the market return, the asset allocation policy return in excess of the market return, and the return from active portfolio management. The asset allocation policy return refers to the fixed asset allocati...
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
Following the trend of economy, it is important to investors to understand that strong economy creates strong stock market. To elaborate further, as stock prices are increased by current and future expectations of earnings, thus without a strong economy it would be difficult for the companies to increase and sustain their earnings (Kong 2013). The economy development is usually calculated using the gross domestic product of a countries. On the other hand, a change is the stock price can also cause a major impact to the consumers and investors directly. Hence, a loss in confidence by investors can cause a downturn in consumer spending in the long term, which will also affect the economy’s output (Aysen 2011). The graph below shows the relationship of stock market price (KLCI) and the GDP of Malaysia in 2009. Thus, it can be concluded that the economy and the stock market has a positive relationship.
This is the rate of return (the discount rate) at which the net present value of the investment is zero, or that is the discount rate at which the discounted income from the project is equal to the investment costs
The Dow Theory had laid down the basic principles of technical analysis. However, with the advent of more advanced techniques and tools the Dow Theory needs some expansion. One of the big problems with the theory is that the conservative nature of a trend-reversal signal. A reversal in the bullish and bearish trend is confirmed when there is an end to successive highs and successive lows respectively. However, it is difficult to predict the end of trends and by the time it gets confirmed the markets have already moved a long way.