Question 1 (25 Marks) a. A financial econometrician thinks that the stock market crash of October 1987 fundamentally changed the risk-return relationship given by the CAPM equation. He decides to test this hypothesis using a Chow test. The model is estimated using monthly data from January 1980 December 1995, and then two separate regressions are run for the sub-periods corresponding to data before and after the crash. The model is rt= a + BRmt + ut so that the excess return on a security at time t is regressed upon the excess return on a proxy for the market portfolio at time t. The results for the three models estimated for shares in British Airways (BA) are as follows: 1981M11995M12 rt = 0.0215 +1.491 I'mt RSS = 0.189 T = 180 1981M11987M10 11 = 0.0163 + 1.308 Imt RSS=0.079 T = 82 1987M11-1995M12 11 = 0.0360 + 1.613 Imt RSS = 0.082 T = 98 i. What are the null and alternative hypotheses that are being tested here, in terms of a and B? (5 marks) ii. Perform the test. What is your conclusion? (10 marks) Question 1 (25 Marks) a. A financial econometrician thinks that the stock market crash of October 1987 fundamentally changed the risk-return relationship given by the CAPM equation. He decides to test this hypothesis using a Chow test. The model is estimated using monthly data from January 1980 December 1995, and then two separate regressions are run for the sub-periods corresponding to data before and after the crash. The model is rt= a + BRmt + ut so that the excess return on a security at time t is regressed upon the excess return on a proxy for the market portfolio at time t. The results for the three models estimated for shares in British Airways (BA) are as follows: 1981M11995M12 rt = 0.0215 +1.491 I'mt RSS = 0.189 T = 180 1981M11987M10 11 = 0.0163 + 1.308 Imt RSS=0.079 T = 82 1987M11-1995M12 11 = 0.0360 + 1.613 Imt RSS = 0.082 T = 98 i. What are the null and alternative hypotheses that are being tested here, in terms of a and B? (5 marks) ii. Perform the test. What is your conclusion? (10 marks)