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Contents

Preface ix Chapter 1 Introduction 1 Organization of the book 3 Useful background 4 Appendix 1.1: Concepts in mathematics used in this book 4 Chapter 2 Basic data handling 9 Types of financial data 9 Obtaining data 15 Working with data: graphical methods 16 Working with data: descriptive statistics 21 Expected values and variances 24 Chapter summary 26 Appendix 2.1: Index numbers 27 Appendix 2.2: Advanced descriptive statistics 30 Chapter 3 Correlation 33 Understanding correlation 33 Understanding why variables are correlated 39 Understanding correlation through XY-plots 40 Correlation between several variables 44 Covariances and population correlations 45 Chapter summary 47 Appendix 3.1: Mathematical details 47 Chapter 4 An introduction to simple regression 49 Regression as a best fitting line 50 Interpreting OLS estimates 53 Fitted values and R2: measuring the fit of a regression model 55 Nonlinearity in regression 61 Chapter summary 64 Appendix 4.1: Mathematical details 65 Chapter 5 Statistical aspects of regression 69 Which factors affect the accuracy of the estimate ߈? 70 Calculating a confidence interval for ß 73 Testing whether ß =0 79 Hypothesis testing involving R2: the F-statistic 84 Chapter summary 86 Appendix 5.1: Using statistical tables for testing whether ß =0 87 Chapter 6 Multiple regression 91 Regression as a best fitting line 93 Ordinary least squares estimation of the multiple regression model 93 Statistical aspects of multiple regression 94 Interpreting OLS estimates 95 Pitfalls of using simple regression in a multiple regression context 98 Omitted variables bias 100 Multicollinearity 102 Chapter summary 105 Appendix 6.1: Mathematical interpretation of regression coefficients 105 Chapter 7 Regression with dummy variables 109 Simple regression with a dummy variable 112 Multiple regression with dummy variables 114 Multiple regression with both dummy and non-dummy explanatory variables 116 Interacting dummy and non-dummy variables 120 What if the dependent variable is a dummy? 121 Chapter summary 122 Chapter 8 Regression with lagged explanatory variables 123 Aside on lagged variables 125 Aside on notation 127 Selection of lag order 132 Chapter summary 135 Chapter 9 Univariate time series analysis 137 The autocorrelation function 140 The autoregressive model for univariate time series 144 Nonstationary versus stationary time series 146 Extensions of the AR(1) model 149 Testing in the AR( p) with deterministic trend model 152 Chapter summary 158 Appendix 9.1: Mathematical intuition for the AR(1) model 159 Chapter 10 Regression with time series variables 161 Time series regression when X and Y are stationary 162 Time series regression when Y and X have unit roots: spurious regression 167 Time series regression when Y and X have unit roots: cointegration 167 Time series regression when Y and X are cointegrated: the error correction model 174 Time series regression when Y and X have unit roots but are not cointegrated 177 Chapter summary 179 Chapter 11 Regression with time series variables with several equations 183 Granger causality 184 Vector autoregressions 190 Chapter summary 203 Appendix 11.1: Hypothesis tests involving more than one coefficient 204 Appendix 11.2: Variance decompositions 207 Chapter 12 Financial volatility 211 Volatility in asset prices: Introduction 212 Autoregressive conditional heteroskedasticity (ARCH) 217 Chapter summary 222 Appendix A Writing an empirical project 223 Description of a typical empirical project 223 General considerations 225 Appendix B Data directory 227 Index 231

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