Unformatted text preview:

Business 35150 John H. CochraneProblem Set 7Part I Short answer questions on readings.Note, if I don’t provide it, state which table, figure, or exhibit backs up your point1. Mitchell and Pulvino(a) Figure 3, Table IV. What accounts for the huge difference between VWRA and RAIM portfolioreturns?(b) What is the meaning of the fact that the two betas differ in Table IV? What kind of securit ydoes this suggest you use to benchmark merger “arbitrage?”(c) (Though t question for class, no need to write or hand in.) Figure 4 suggests all the informationis in about 4 big outliers. Does this w orry you?(d) The Mkt Highin Table IV is positive and significant. This is also where the bent line of Figure4 intersects the vertical axis, the intercept of the bent line. So, do we conclude that Merger“Arbitrage” is profitable after accounting for its option-like component?(e) In Table VI 2159, the effect seems much stronger in cash transactions. Does this argue againsttheir story; i.e. should the betas be the same any way you do it?(f) How is Figure 5 / Table VIII looks like a repeat of Figure 4 / Table IV. How are they different?What are the advantages and disadvantages of the two approac hes?2. Asness Et. Al.(a) Why, according to Asness & co., might hedge funds seem to have returns that are smootherand lower beta than in fact?(b) If returns were independent over time, how would adding lagged returns affect betas — increase,decrease, or stay the same as you add lags?(c) Overall, when we add lagged betas, do hedge fund betas seem to increase, decrease, or staythe same?(d) Are alphas meaningful as we add lagged betas? What happens to alphas as w e add laggedbetas?(e) What interpretation do Asness & co. give to the difference between up and down marketbetas? Can you think of a different interpretation?(f) A conceptual issue for class discussion, no answer required (p. 10, bottom left). Suppose amanger mov es in and out of the market, according to some signal, and does so correctly. Isthis alpha? Should we correct for such time-varying beta in our performance attribution?3. Lamont and Thaler(a) There are three ways to buy Palm stock each with a differen t price. What are they?(b) L&T document that short costs keep you from exploiting different prices But why, accordingto them, are prices wrong in the first place?(c) Looking at Figure 1-4, and 3 in particular, do negative stubs seem to quic kly converge? Doesnews seem to affect the stub?(d) How is “real world” shorting different from our frictionless textbook? Note two extra costsand risks(e) Was there a lot of shorting in the “overpriced” subsidiaries? Was there more or less than inthe parents? Did the sub shorting increase or decrease over time?1(f) If w e can’t short, let’s buy November (data of spinoff) puts, or create a synthetic short positionin options mark ets. Will this work and if not why not?(g) How do turnover and institutional ow nership of Palm compare to that of 3Com? What con-clusions do L&T draw from these facts?(h) What happened to 3Com price during this episode? What conclusions to L&T draw?4. Cochrane Stocks as Money(a) According to Coc hrane, which of money and bonds is like which one of 3Com/Palm ?(b) How is the “overpricing” of money associated withi. Turnoverii. Supplyiii. Short sales constraintsiv. “Specialness” of the security (Palm, money); presence of substitutes(c) Is turnover associated with “overpricing” for 3Com/Palm in the right direction?(d) How muc h does a typical Palm investor lose by holding Palm, not 3Com? Is this “a lot” or“not much ”?(e) What’s the point of Figure 5? (Short)(f) Wait, monetary theory says you are willing to put up with low returns on money becausethere is no substitute. If you want to bet on Palm, wh y not buy 3Com or use options instead?(Point to evidence here in Table 1, Figure 7.)(g) To Cochrane, the fact that 3Com fell is explained. How? What do Lamont and Thaler sayabout it?(h) Cochrane thinks one crucial special feature marks “bubbles” in addition to “I wish I soldyesterday” price rises and declines. What is it?Part II ComputerYou’re ready. It’s time to form some portfolios.We’re going to replicate Carhart’s results, and then extend the idea a bit. In doing so, you learn howto form portfolios the wa y Fama and French do.Load the matlab workspace fund_factor_data from the class website. This has all you need; onceyou execute the command load fund_factor_data, all the variables are there in your workspace for youto play with. x is a 576x3668 matrix of percent monthly returns on equity mutual funds. dates is acorresponding 576x1 matrix with the dates for the return observations. If a fund is not operating in agiven date, either has not been started yet or went out of business you will see a NaN (not a number)code instead of a return in x. The workspace also contains Fama French factors and a momentum factorrmrf, smb, hml, umd and rf for the same time period. The x returns are total, so your first step is rx =x-rf.The first thing we’ll do is to replicate Carhart in this longer data. Form Carhart portfolios, sortingon one year returns. Start with observation 12 (December of the first year). Find the funds that have 12mon ths of returns leading up to that date, i.e. have numbers and not NaNs continuously for observations1:12. Find the mean return over the first y ear for each such fund.Now, form an equally weighted portfolio (i.e. just average the returns across funds) of the 1/10thworst of these funds, the next 1/10th, etc. to the best 1/10th, for the next y ear. The result should be12 months of returns on 10 portfolios, valid from observation 13 (January, year 2) to 24.Some of your funds will disappear over the return year. If you ignore them, taking the portfolio returnover the non-NaN return for each month, that has the same effect as taking the money from a dead fundand redistributing it equally to all the others. Now you know why we do equal-weight portfolios!2Repeat this procedure at observation 24 (December, year 2) and so forth, to create 10 portfoliossorted on the basis of previous year’s return. (Obviously, you’ll do this in a loop. See the programminghin ts at the end of the problem set!) Include in your results the winner-loser (10-1) portfolio return.Now comes the easy part1. Evaluate these mutual-fund portfolios:(a) Make a table of mean returns and standard errors (√ ) for the 11


View Full Document

Chicago Booth BUSF 35150 - Problem Set 7

Documents in this Course
CLONES

CLONES

8 pages

Load more
Download Problem Set 7
Our administrator received your request to download this document. We will send you the file to your email shortly.
Loading Unlocking...
Login

Join to view Problem Set 7 and access 3M+ class-specific study document.

or
We will never post anything without your permission.
Don't have an account?
Sign Up

Join to view Problem Set 7 2 2 and access 3M+ class-specific study document.

or

By creating an account you agree to our Privacy Policy and Terms Of Use

Already a member?