Electronic Management of Assessment (EMA): This assignment should be
submitted online via Turnitin by the given deadline. You will find a Turnitin link on the
module’s eLP site.

Instructions on AF7005 coursework assignment:
You are required to answer all the following questions in this coursework assignment.
Question 1: (10 Marks)
Construct an investment strategy using the international stock market indices data (from the
database provided on the Blackboard site of the module). The strategy should be based on the
returns transmission effects across the stock markets in different geographical zones worldwide.
In particular, the strategy will focus on the idea of “heat waves” and “meteor showers” effects
originally introduced by Engle, Ito and Lin (1990).
Requirements:
You will estimate the parameters of the respective econometric models in the computer lab
(examples of estimations will be covered in the workshop sessions during the semester). Those
results will serve as the basis for the construction of an investment strategy and generation of

signals for hypothetical trading transactions. Your task will be to use the obtained results and
simulate the chosen strategy in Excel. In particular, you should do the following:
A) Briefly discuss the econometric model, which you have chosen to use for your
trading strategy, and the relationships between the stock market indices, which it
explains.
(4 marks, 200 words approx.)
B) Calculate the overall return from your strategy for the entire period of the analysis.
(6 marks, 100 words approx.)
Question 2: (20 Marks)
Using the results for your model from Question 1 above, perform further analysis of the
performance of your trading strategy:
A) Assess the forecasting performance of the model and your strategy: you can use the
direction quality measures (or any other measures of forecasting performance, which
you find appropriate and can reasonably justify their use).
(10 marks, 200 words approx.)
B) Discuss the obtained results by commenting on the profitability of the strategy, its
risk and the stability of the returns.
(10 marks, 500 words approx.)
Question 3: (10 Marks)
Estimate the following VAR model with appropriate lag-order containing four macroeconomic
variables: annual inflation rate, output growth, Federal Funds Rate and market risk premium
for the US:

???????? = ???? + ∑????. ????????−????
????
????
+ ????????
where: the vector ???????? ≡ [????, ????, ????, ????????????], ???? is the annual CPI inflation rate, ???? is growth rate of
Index of Industrial Production, ???? is the Federal Funds Rate and ???????????? is the market risk premium
in the US. The Market Risk Premium is the excess return on a broad stock market index, such
as the S&P 500 index, over risk-free rate such as the rate on one-month US treasury bills. ???? is
a vector of constants, ???? is a matrix of coefficients, ???? is the lag order and ????????
is a IID shocks with
expected mean zero and covariance matrix Ω.
The data required to answer this question is uploaded on the Blackboard site of this module.
The name of the file is “VAR Data for Assignment”. Sample Size January 1985 to November
2018. (Please note that you will have to calculate the growth rate of Index of Industrial
Production. Similarly, you will have to calculate the returns on S&P 500 index to calculate
the ????????????).
You are required to perform following tasks:
A) Determine the optimum lag order p of the above model using suitable information
criteria and check the stability of the model. Comment on the stability of the model.
B) Estimate and present the impulse response of the market risk premium to shocks in
interest rate (r), inflation and output growth over the next twelve months and comment
on the result.
(10 marks, 400 words approx.)
Question 4: (30 Marks)
Construct the pairs trading strategy between five pairs of assets using cointegration technique.
The assets can be shares of individual companies or commodities or stock indices or commodity
indices. You should use at least 10 years of data at daily frequency for all the assets. You are,
however, free to choose the start and end date of the sample.
Requirements
A) You are required to test for stationarity of the data using appropriate unit-root tests, test
for cointegration and establish that there is a long-run relation between the asset pairs.

B) Present and briefly discuss the parameters of the five cointegrating models between five
pairs of assets
C) Design pair-trading strategy for all the five pairs of assets based on the cointegrating
model estimated in the above question and evaluate the profitability of the strategy.
(30 Marks, 600 words approximately)
Question 5 (30 Marks)
Estimate Error Correction Models (ECMs) between the five pairs of assets that you have
identified in Question 4 and answer following:
A) Explain the short-run and the long-run relationship between the identified five pairs of
assets.
B) Comment on the speed at which the long-run relationship between these five pairs of
assets is corrected.
(30 Marks, 1000 words approximately)
Draft Assessment Brief – Postgraduate