Assignment 1 Answers

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Financial Econometrics (AP/ECON 4140 S2)
Winter 2013
Instructor: Yasin Janjua
Assignment # 1
Total Points (100)

Part I: Do the following Questions

1. Define American Call/Put option10 pts

Answer
Options allow investors to hedge against risk. If one expects stock prices to rise, then he/she may like to invest in stocks. However, buying stocks also entails risk because of price fluctuation. The risk will be potentially large in case price falls to zero. In order to avoid risk one may like to buy a call option. An American call option gives one the right, but not an obligation, to buy a specified number of shares of a stock for a specified price called exercise or strike price before the maturity date or on the maturity date (a future date). In comparison to European options, American options can be exercised before the maturity date.

2. Define Skewness and Kurtosis and also explain why these are useful10 pts Answer
Skewness and Kurtosis are measures of dispersion of the data around its mean as they measure shape of probability distribution. Skewness measures the degree of asymmetry. Its value ranges between 0 and 1, where 0 implies symmetry (normal distribution). A positive skewness indicates a relatively long right tail and vice versa. Kurtosis indicates the extent to which probability is concentrated in the center and the tail of the distribution. A value of 3 indicates normal distribution, while a value of K > 3 indicates heavy tails. The skewness and kurtosis of a random variable are Sk (n,p) = E {X – E(X)}3 / σ3 and K = E {X – E(X)}4 / σ4

3. Read Sewell (2011) paper and
a. define calendar effects, and
b. discuss briefly seven different calendar effects identified in literature (your answer shall not exceed one page) 30 pts Answer
a. Calendar effects are viewed as cyclical anomalies in returns, where the cyclical patterns in data can be ascribed to change in volume and activity...
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