Problem 2 - Factor Model Testing [35 marks]1 For this problem, you are reo uired to test a factor model. Download the file Econ 9535 -i13 P2 Data.rrisrr from the course website. Use the data included in the file for your calculations and use the ta bles, also provided in the file, to report your results. Please do not modify the format and location of these tables as some of them are programeci to take your answers and compute the inputs for subseouEnt sections of the problem. Specifically, areas highlighted in blue will compute some of the inputs required for subsequent sections. The purpose of automating this process is to save you time when solving the assignment. Use either MS Excel [recommended], MATLAB, R or Python for your calculations. Upload your spreadsheet and oode with your assignment submission. a] item Em ber that cross-sectional tests of factor models are performed in two stages. Perform the firststuge regression for each stock in Table 1 of the spreadsheet provided for this problem {l.e., stocks at to i]. Hemrt your results in Table 2. Remember that the first stage regression follows the specification Hi, 2 a] + Hymtlt + is\". This stage provides an estimate of the Secan'ty raracteristic Line [SCI]. Let the market index be a proxy for the ma ricet portfolio. [5 marks] b] For the secondstage regression, we will use the following specification: if = in + 11.3\"... + co. Recall that this stage evaluates if the Security Market tine [Emu holds across securities. Notice that this specification is similar to the one presented in equation 3.43 in Campbell [Elli], but in this ca se, we are including the inteme pt AD. i. what are the hypotheses for in, and Al? [1 marks] ii. Perform the second stage regression and report your results in Table 4. [3 marks] iii. Interpret your results givEn the hypotheses for .10, and 1.1. Does the single factor model properly characterize the crosssection of stock returns? [1 marks] c] Table 5 of the spreadsheet provided for this problem groups the nine stocks in the sample [i.e.y stocks A to i] into three portfolios that maximize the dispersion of betas in the resulting portfolios. i. Use this data to conduct the fnststoge regression on the three portfolios and report your results in Table 5. [3 marks] ii. Conduct the second stage regression on the three portfolios and report your results in Ta ble 3. [3 marks] iii. Are there any discrepancies between the results obtained in section {c.ii and [c.ii] and those obtained in sections {a} and [b]? why? what do these results imply about the single factor model characterization of cross-section al stock returns? [2 marks] d] Explain itoll's critigae in the contest of the tests performed in sections [a], {hi and [c]. [2 marks] e] Now] consider the second factor in Table 1 of the spreadsheet provided for this problem. i. Perform the rst stage regression, RE, = 1! + ym'm + yzfly + E\". and report your results in Table 9. [Hint In this case, you need to use multivariate regrEssion to estimate the two factor loadings, or betas, of each stock]. [5 marks] ii. 1.rtrhat is the specification for the semnd stage regression? what are the hypotheses for .19, 3.1 and 1.1? [3 marks] iii. Perform the second stage regression and report your results in Table 11. [3 marks] iv. Does a two-factor model provide a better characterization of the cross-section of stock returns than the one provided by a one-factor model? why? [2 marks]