You Invest in a Country Named Paf You Will Try to Assess Whether the Two Factors Have

Essay

You invest in a country named Paf. You consider explaining the difference in returns by two common factors, with a linear factor model as given in Equation (6.9). Your candidate for factors are movements in interest rates and changes in the popularity of the president of Paf, as measured by polls. The various values of the factor returns and of the returns on four stocks (A, B, C, and D) for the ten past periods are given below:
$$\begin{array} { r c c r r r r } \hline \text { Periad } & \text { Interet Rate } & \text { Papularity } & { \mathbf { A } } & { \text { B } } & { \mathbf { C } } & { \mathbf { D } } \\\hline 1 & - 3 \% & 2 \% & - 2.57 & - 4.43 & - 2.16 & - 5.02 \\2 & 2 \% / 6 & 7 \% & 1.90 & 2.53 & 2.01 & 3.81 \\3 & 5 \% & 6 \% & 5.46 & 7.42 & 4.10 & 9.17 \\4 & - 2 \% & 4 \% & - 1.62 & - 4.70 & - 0.59 & - 3.24 \\5 & 4 \% & - 3 \% & 4.51 & 6.43 & 3.01 & 8.79 \\6 & 2 \% & 4 \% & 2.16 & 1.56 & 1.36 & 4.66 \\7 & - 5 \% & - 7 \% & - 5.54 & - 4.73 & - 4.08 & - 8.60 \\8 & - 6 \% & 0 \% & - 5.83 & - 8.12 & - 5.41 & - 11.47 \\9 & 3 \% & 2 \% & 3.04 & 4.71 & 2.42 & 6.43 \\10 & 1 \% & - 2 \% & 1.18 & 2.44 & 0.00 & 2.50 \\\hline\end{array}$$ You will try to assess whether the two factors have an influence on stock returns. To do so:
a. Estimate the factor exposures for each of the four assets. (You can do a times-series regression for each asset against the two factors.)
b. Are the factors «priced», that is, is there a relation between mean returns on the assets and their factor exposures? (You can do a cross-sectional regression between the mean return on the asset and its exposures, that is, you have one observation for each asset.)