Multiple Choice Test Bank Questions No Feedback – Chapter 1

Correct answers denoted by an asterisk.

1. The linear relationship between two variables (y and x) can be represented by

the equation y = a + bx . Which of the following statements is true?
(I) Parameter a is termed the intercept
(II) Parameter a is termed the slope
(III) Parameter b is termed the gradient
(IV) Parameter b is termed the constant.
(a) I and IV only
(b)* I and III only
(c) II and III only
(d) II and IV only.

2. Assume that the relationship between a company’s stock price (y) and dividends
paid per share (x) is linear. If the slope of the equation is 0.50 and the intercept is
30, what would be the expected stock price if the dividend paid was 3?
(a) 33
(b) 30.50
(c)* 31.5
(d) 30.

3. Which of the following values are closes to the roots of the following quadratic
equation: y = x - 4 x + 1?
2

(a) 0 and 4
(b) 1 and 4
(c) 0.5 and 3
(d)* 0.3 and 3.7.
4. Consider the following graphs.

(A) (B)

Which of the following statements is true?

(a) A is depicts a non-linear relationship between y and x
(b) B is depicts a linear relationship between y and x
(c)* A and B depict linear and non-linear relationships between y and x,
respectively
(d) A and B depict non-linear and linear relationships between y and x,
respectively.

5. Which of the following statements is true about graph (A) above?

(a)* The intercept of the graph is positive and its slope is negative
(b) The intercept of the graph is negative and its slope is positive
(c) Both the intercept and slope of the graph are positive
(d) It is impossible to say anything about the intercept and slope without seeing the
mathematical equation.

6. The simplest possible way of writing 3x5 × 7x3 is:

(a) 21 x5 × x3
(b) 21 x15
(c) * 21x8
(d) 21x53.

7. What are the roots of the equation y = 2x2 + 2x – 4?

(a) * –2 and 1
(b) –1 and 2
(c) –2 and 2
(d) –2 (repeated).

8. What are the roots of the equation y = x2 + 2x – 6 closest to?

(a) –4 and 2

(b) * –3.65 and 1.65

(c) –7.3 and 3.3

(d) Both complex.

9. ‘x to the power 3’ could be written:

(a) 3x
(b) 3x3
(c) * x3
(d) 3x × 3x × 3x.

10. Another way of writing elog(x) is:

(a) * 1
(b) log(x)
(c) ex
(d) x.

11. Log(1) is:

(a) 1
(b) * 0
(c) 2.71828…
(d) Undefined.

2 2

åå x ij
12. Writing out all the terms in the expression i =1 j =1 would lead to:
(a) * x11 + x12 + x21 + x22
(b) x11 × x12 × x21 × x22
(c) x1 + x2
(d) x11 + x22.

åy
13. i =1 is equal to:

(a) * 5y
(b) y
(c) y5
(d) 5y5.

14. What is the (first order) derivative of the function y = x - 4 x + 1?

2

(a) 2 x - 4 x + 1
(b) 2 x - 4 x
2

(c)* 2 x - 4
(d) 2 x - 4 + 1 .

15. What is the second order derivative of the function y = 6 x + 3x + 4 x + 2 ?

4 3 2

(a) 24 x + 9 x + 8 x
3 2

(b)* 72 x + 18 x + 8
2

(c) 24 x + 9 x + 8
3 2

(d) 6 x + 3x + 4 x .
4 3 2

16. The derivative of log(5x) is:

(a) 5/x
(b) * 1/x
(c) 5log(x)
(d) 5/log(x).

17. The derivative of e4x-2 is:

(a) 4/(4x-2)
(b) (4x-2)e4
(c) (4x-2)e4x-2
(d) * 4e4x-2.

18. If A is of dimension 1 × 4 and B is of dimension 4 × 1, what is the most

accurate term to describe the result of the matrix multiplication AB?

(a) * A scalar
(b) A column vector
(c) A row vector
(d) A matrix.

æ3 1ö
ç ÷
A = 2ç 4 6÷ æ 4ö
ç 2 2÷ B = 4ç ÷
19. If matrices è ø and è 8 ø , what is AB?
æ 160 ö
ç ÷
ç 512 ÷
ç ÷
(a)* è 192 ø
æ 20 ö
ç ÷
ç 64 ÷
ç ÷
(b) è 24 ø
æ 40 ö
ç ÷
ç128 ÷
ç ÷
(c) è 48 ø
æ 80 ö
ç ÷
ç 256 ÷
ç ÷
(d) è 96 ø .

20. The rank of matrices A and B from Question 19 are:

(a) 1 and 2, respectively
(b)* 2 and 1, respectively
(c) 1 and 3, respectively
(d) 3 and 1, respectively.

21. For two conformable matrices A and B, expanding the parentheses of (AB)-1
gives:
(a) A-1B-1
(b) * B-1A-1
(c) BA
(d) AB.

æ3 1ö
C =ç ÷
22. What is the inverse of matrix è 4 6ø?
æ 0.43 -0.07 ö
ç ÷
(a) è 0.29 0.21 ø
æ 0.43 -0.07 ö
ç ÷
(b)* è -0.29 0.21 ø
æ 0.43 0.07 ö
ç ÷
(c) è 0.29 0.21 ø
æ -0.43 0.07 ö
ç ÷
(d) è 0.29 -0.21ø .

23. The rank of a square matrix is also:

(a) The product of the eigenvalues

(b) The sum of the eigenvalues
(c) * The number of non-zero eigenvalues
(d) The number of correlated rows or columns.

24. The trace of matrix C is

(a)* 9
(b) 8
(c) 7
(d) 6.

25. The point where the capital market line is tangential to the efficient frontier is
(a) The point where the portfolio returns are minimised
(b) The point where the portfolio returns are maximised
(c) The point where the portfolio’s Sharpe ratio is minimised
(d)* The point where the portfolio’s Sharpe ratio is maximised.

26. The central limit theorem states that

(a)* The sampling distribution of the mean of any random sample of observations
will tend towards the normal distribution with mean equal to the population mean
as the sample size tends to infinity
(b) The sampling distribution of the mean of any random sample of observations
will tend towards the normal distribution with mean equal to the population mean
as the sample size tends to zero
(c) The cumulative distribution function of the mean of any random sample of
observations will tend towards the normal distribution with mean equal to the
population mean as the sample size tends to infinity
(d) The probability distribution function of the mean of any random sample of
observations will tend towards the normal distribution with mean equal to the
population mean as the sample size tends to infinity.

27. Consider the following data series: 11, 10, 6, 8, 4, 3, 7. What is its semi-
interquartile range of this series?
(a) 6
(b) 5
(c) 4
(d)* 3.
28. Consider the following two graphs:

(A) (B)

Which of the following statements is true if A represents a normal distribution?

(I) The skewness of the distribution plot A is 0 and its kurtosis is 3
(II) The skewness of the distribution plot B is 0 and its kurtosis is 3
(III) The excess kurtosis of the distribution plot A is 3
(IV) The excess kurtosis of the distribution plot B is 0.

(a) Both (I) and (III) are true

(b) Only (III) is true
(c)* Only (I) is true
(d) Both (I) and (IV) are true.

29. Suppose that we have a function given by y = a1 + a2x. a1 and a2 are,

respectively,
(a) The domain and range of the function
(b) The order and power of the function
(c) * The intercept and slope of the function
(d) The slope and intercept of the function.

30. What are the roots of the equation y = 3 + 4x + 2x2?

(a) 2 and –4
(b) 0.5 and –2
(c) 2 and 2
(d) * This function has no real roots.

31. (x3)2 simplifies to

(a) x5
(b) * x6
(c) x
(d) The expression cannot be simplified.

32. Which of the following three equations is/are correct regarding the summation
operator?
∑!
"#$ 𝑥" + ∑!
"#$ 𝑧" = ∑! "#$ (𝑥" + 𝑧" )
(i)
∑"#$ 𝑥" 𝑧" = ∑!
!
"#$ 𝑥" ∑!
"#$ 𝑧"
(ii)
∑"#$ 𝑐𝑥" = 𝑐 ∑!
!
"#$ 𝑥"
(iii)

(a) (iii) only

(b) * (i) and (iii) only
(c) (i) and (ii) only
(d) (i), (ii) and (iii).

33. What is ∏%&#$ 𝑘 %?

(a) * 216
(b) 35
(c) 6
(d) 7776.

34. The second order derivative of a quadratic function will be:

(a) A cubic function
(b) A quadratic function
(c) A linear function
(d) * A constant.

35. Using the chain rule or otherwise, what is the (first) derivative of the following
function? y = (2x2 + 4x – 6)3
(a) 3(2x2 + 4x – 6)2
(b) (4x + 4)2
(c) * 3(2x2 + 4x – 6)2(4x + 4)
(d) 3(2x2 + 4x – 6)3(4x + 4)2.

Multiple Choice Test Bank Questions No Feedback – Chapter 2

Correct answers denoted by an asterisk.

1. Financial econometrics can best be described as

(a)* The application of statistical techniques to problems in finance
(b) The application of mathematical models to problems in economics
(c) The application of financial techniques to problems in economics
(d) None of the above.

2. Which of the following is a serious problem encountered by applied

econometricians in economics?
(a) Small samples problems
(b) Measurement error
(c) Data revisions
(d)* All of the above.

3. Which of these is a characteristic of financial data?

(a) They are observed at much lower frequencies than macroeconomic data
(b) The number of observations is usually very small
(c)* They are considered to be very noisy
(d) It is easy to separate underlying trends from random and uninteresting features.

4. Data that have been collected over a period of time on one or more variables is
referred to as
(a) Cross-sectional data
(b) Time-cross-sectional data
(c)* Time-series data
(d) Panel data.

5. Data that have been collected on one or more variables at a single point in time
is referred to as
(a)* Cross-sectional data
(b) Time-cross-sectional data
(c) Time series data
(d) Panel data.

6. Data that have both time series and cross-sections is referred to as

(a) Cross-sectional data
(b) Time-cross-sectional data
(c) Time-series data
(d)* Panel data.

7. An individual invested £106.40 in the stock market and the value of his
investment two years later is £138.22. What are the simple and continuously
compounded returns on his investment?
(a) 26% and 30%, respectively
(b) –29% and -34%, respectively
(c)* 30% and 26%, respectively
(d) 30% and 30%, respectively.
8. An individual has £10000 capital to invest in the stock market. He invests 30%
of his capital in stock A, 25% in stock B and 45% in Stock C. What is the return
on his/her portfolio assuming that the simple returns on stocks A, B and C are 5%,
10% and 12%, respectively?
(a)* 9.0%
(b) 9.7%
(c) 9.3%
(d) 9%.

The average nominal annual rent in the US denominated in dollars and the CPI
(2008 levels) are given in the table below:
Year Average annual rent (US CPI (2008 levels)
Dollars)
2008 9908 100
2009 9998 99.7
2010 10012 101.3
2011 10180 104.5
2012 10396 106.7

9. What is the 2008 average annual rent in 2012 terms?

(a) 9743
(b)* 10572
(c) 9286
(d) 11093.

10. What is the 2012 average annual rent in 2008 terms?

(a)* 9743
(b) 10572
(c) 9286
(d) 11093.

11. The numerical score assigned to the credit rating of a bond is best described as
what type of number?
(a) Continuous
(b) Cardinal
(c)* Ordinal
(d) Nominal.

12. Suppose that we wanted to sum the 2007 returns on ten shares to calculate the
return on a portfolio over that year. What method of calculating the individual
stock returns would enable us to do this?
(a)* Simple
(b) Continuously compounded
(c) Neither approach would allow us to do this validly
(d) Either approach could be used and they would both give the same portfolio
return.

13. If we wish to compare the spread of two series with considerably different
mean values, which of the following measures would be the most appropriate?
(a) The semi-interquartile range
(b) The standard deviation
(c) The range
(d) * The coefficient of variation.

14. For a series with a negative skew in its distribution (a long left tail), which of
the following best describes the relationship between its measures of central
tendency?
(a) mean > median > mode
(b) * mode > median > mean
(c) mode > mean > median
(d) median > mode > mean.

15. Which of the following statements is TRUE concerning the correlation

between two series?
(a) * It is unit-free
(b) It scales with the product of the units of the two series
(c) It scales with the ratio of the units of the two series
(d) It will take the value –1 if there is no association between the two series.

16. What is the sum of the following infinite set of terms? 5, 2.5, 1.25, 0.625, …
(a) Infinity
(b) 5
(c) 20
(d) * 10.

17. What is the sum of the first 12 terms in the following sequence? 12, 24, 48, …
(a) * 49,140
(b) 24,576
(c) 768
(d) 98,292.

18. If I have £10,000 now and I want it to grow by 50% within eight years, what
interest rate, compounded annually, is required (to one decimal place)?
(a) * 5.2%
(b) 6.2%
(c) 4.6%
(d) 7.4%.

19. If a savings account pays a nominal interest rate of 10% per year, compounded
monthly, what is the effective interest rate to one decimal place?
(a) 11.2%
(b) 9.5%
(c) 10.0%
(d) * 10.5%.

20. If you place £10,000 in a savings account, how long would it take to reach
£20,000 assuming an annual interest rate of 3%, continuously compounded,
rounded to the nearest year?
(a) 26
(b) 34
(c) *23
(d) 20.

21. What would be a fair price to pay today, to the nearest dollar, for a zero
coupon bond having exactly six years to maturity and to be redeemed at $1000 if
the annual discount rate is 6%?
(a) $1000
(b) * $747
(c) $864
(d) $553.

22. Which of the following statements is FALSE concerning the internal rate of
return?
(a) For projects where the cashflow payments change sign, there can be more than
one internal rate of return
(b) The internal rate of return is the discount rate that sets the net present value of
all of the cashflows to be received equal to the asset’s purchase price
(c) * In order to calculate an internal rate of return, all of the incoming cashflows
must be identical
(d) We cannot calculate a different internal rate of return for each cashflow.

Multiple Choice Test Bank Questions No Feedback – Chapter 3

Correct answers denoted by an asterisk.

1. Regression is concerned with describing and evaluating the relationship

between
(a) A dependent variable and regressands
(b) An independent variable and regressors
(c)* A dependent variable and regressors
(d) An effect variable and explained variables.

2. What does a positive linear relationship between x and y in a simple regression

imply?
(a) Increases in the independent variable are usually accompanied by increases in
the regressor
(b) The relationship between x and y cannot be explained by a straight line
(c) Decreases in the independent variable is usually accompanied by increases in
the regressors
(d)* Increases in the regressor are usually accompanied by increases in the
dependent variable.

3. Which of these is NOT a reason for adding a disturbance term to a regression

model yt = a + b xt + ut ?
(a) Some determinants of the effect variable may be omitted from the model
(b) Some determinants of the effect variable may be unobservable
(c)* Some determinants of the independent variable may be omitted from the
model
(d) There may be errors in the way that the dependent variable is measured which
cannot be modelled.

4. Which of these is not a standard method for estimating econometric models?

(a) Ordinary least squares
(b) The method of moments
(c)* Method of generalised squared moments
(d) Maximum likelihood.

5. The method of estimating econometric models which involves fitting a line to

the data by minimising the sum of squared residuals is the
(a)* Method of ordinary least squares
(b) Method of moments
(c) Method of generalised squared moments
(d) Method of maximum likelihood.
6. Suppose you have 5-year annual data on the excess returns on a fund manager’s
portfolio (‘fund ABC’) and the excess returns on a market index (where rABC is the
rf
return on fund ABC, is the risk-free rate and rM is the return on the market index):
Year t Excess return on fund ABC Excess return on market
rABC ,t - rf ,t index
rM ,t - rf ,t
1 14.0 16.0
2 32.0 21.7
3 11.6 6.0
4 21.2 16.2
5 17.4 11.0

What is the estimated alpha ( â ) for Fund ABC?

(a) 2.3
(b)* 3.3
(c) 4.3
(d) 5.3.

7. Given the data in Question 6, what is the estimated beta ( b̂ ) of Fund ABC?
(a) 3.1
(b) 2.1
(c)* 1.1
(d) None of the above.

8. Suppose that the unbiased estimator of the standard deviation of the disturbance
(s) is 5.1. What is the nearest value to the standard errors of the estimated CAPM
alpha ( â ) of Fund ABC from Question 6?
(a) 3.5
(b) 4.5
(c) 5.5
(d)* 6.5.

9. The estimated alpha ( â ) and beta ( b̂ ) of a rival fund, Fund DEF, are 2.3 and 3.1,
respectively. If the expected market risk premium is 12%, what would we expect
the excess return of Fund DEF to be?
(a)* 39.5%
(b) 30.7%
(c) 5.4%
(d) 64.8%.
 cov ( ui , u j ) = 0
10. What is the most appropriate interpretation of the assumption
concerning the regression disturbance terms?
(a) The errors are nonlinearly independent of one another
(b) The errors are linearly dependent of one another
(c) The covariance of the errors is constant and finite over all its values
(d)* The errors are linearly independent of one another.

11. The estimators â and b̂ determined by OLS will be the Best Linear Unbiased
Estimators (BLUE) if which of the following assumptions hold?
(I) The errors have zero mean
(II) The variance of the errors is constant and finite over all values of the
independent variable(s)
(III) The errors are linearly independent of one another
(IV)There is no relationship between the error and corresponding independent
variables
(a) I and II only
(b) I, II and III only
(c) II, III and IV only
(d)* I, II, III, and IV.

12. Standard errors

(a) Give us an idea of the deviation of the errors from their mean
(b) Measure the reliability of the independent variables
(c)* Give us an idea of the precision of estimates of a and b
(d) Measure the reliability of the dependent variables.

Suppose you have calculated the following regression results:

yˆ t = 1.25 + 0.64 xt . The standard errors of â and bˆ are 1.22 and 0.58, respectively.

13. Using the test of significance approach, what is the test statistic value of a
hypothesis to test whether the true value of b statistically different from zero?
(a)* 1.10
(b) 0.91
(c) –0.62
(d) Cannot say without more information.

14. Assuming there are 1000 observations in your sample, what are the test statistic
and critical value of a two-sided hypothesis test of whether the true value of b
statistically different from zero be given a 5% significance level?
(a)* 1.10 and 1.96, respectively
(b) 0.91 and 1.65, respectively
(c) –0.62 and 1.96, respectively
(d) Cannot say without more information.

15. Consider a bivariate regression model with coefficient standard errors calculated
using the usual formulae. Which of the following statements is/are correct regarding
the standard error estimator for the slope coefficient?
(i) It varies positively with the square root of the residual variance (s)
(ii) It varies positively with the spread of X about its mean value
(iii) It varies positively with the spread of X about zero
(iv) It varies positively with the sample size T

(a) * (i) only

(b) (i) and (iv) only
(c) (i), (ii) and (iv) only
(d) (i), (ii), (iii) and (iv).

16. In a time-series regression of the excess return of a mutual fund on a constant

and the excess return on a market index, which of the following statements should
be true for the fund manager to be considered to have ‘beaten the market’ in a
statistical sense?
(a) * The estimate for α should be positive and statistically significant
(b) The estimate for α should be positive and statistically significantly greater than
the risk-free rate of return
(c) The estimate for β should be positive and statistically significant
(d) The estimate for α should be negative and statistically significant.

17. What result is proved by the Gauss–Markov theorem?

(a) That OLS gives unbiased coefficient estimates
(b) That OLS gives minimum variance coefficient estimates
(c) * That OLS gives minimum variance coefficient estimates only among the class
of linear unbiased estimators
(d) That OLS ensures that the errors are distributed normally.

18. The type I error associated with testing a hypothesis is equal to

(a) One minus the type II error
(b) The confidence level
(c) * The size of the test
(d) The size of the sample.

19. Which of the following is a correct interpretation of a ‘95% confidence interval’

for a regression parameter?
(a) * We are 95% sure that the interval contains the true value of the parameter
(b) We are 95% sure that our estimate of the coefficient is correct
(c) We are 95% sure that the interval contains our estimate of the coefficient
(d) In repeated samples, we would derive the same estimate for the coefficient 95%
of the time.

20. Which of the following statements is correct concerning the conditions

required for OLS to be a usable estimation technique?
(a) * The model must be linear in the parameters
(b) The model must be linear in the variables
(c) The model must be linear in the variables and the parameters
(d) The model must be linear in the residuals.

21. Which of the following is NOT a good reason for including a disturbance term
in a regression equation?
(a) It captures omitted determinants of the dependent variable
(b) * To allow for the non-zero mean of the dependent variable
(c) To allow for errors in the measurement of the dependent variable
(d) To allow for random influences on the dependent variable.

22. Which of the following is NOT correct with regard to the p-value attached to a
test statistic?
(a) * p-values can only be used for two-sided tests
(b) It is the marginal significance level where we would be indifferent between
rejecting and not rejecting the null hypothesis
(c) It is the exact significance level for the test
(d) Given the p-value, we can make inferences without referring to statistical tables.

23. Which one of the following is NOT an assumption of the classical linear
regression model?
(a) The explanatory variables are uncorrelated with the error terms.
(b) The disturbance terms have zero mean
(c) * The dependent variable is not correlated with the disturbance terms
(d) The disturbance terms are independent of one another.

24. Which of the following is the most accurate definition of the term ‘the OLS
estimator’?
(a) It comprises the numerical values obtained from OLS estimation
(b) * It is a formula that, when applied to the data, will yield the parameter estimates
(c) It is equivalent to the term ‘the OLS estimate’
(d) It is a collection of all of the data used to estimate a linear regression model.

25. Two researchers have identical models, data, coefficients and standard error
estimates. They test the same hypothesis using a two-sided alternative, but
researcher 1 uses a 5% size of test while researcher 2 uses a 10% test. Which one
of the following statements is correct?
(a) Researcher 2 will use a larger critical value from the t-tables
(b) * Researcher 2 will have a higher probability of type I error
(c) Researcher 1 will be more likely to reject the null hypothesis
(d) Both researchers will always reach the same conclusion.

26. Consider an increase in the size of the test used to examine a hypothesis from
5% to 10%. Which one of the following would be an implication?
(a) * The probability of a Type I error is increased
(b) The probability of a Type II error is increased
(c) The rejection criterion has become more strict
(d) The null hypothesis will be rejected less often.

27. What is the relationship, if any, between the normal and t-distributions?
(a) A t-distribution with zero degrees of freedom is a normal
(b) A t-distribution with one degree of freedom is a normal
(c) * A t-distribution with infinite degrees of freedom is a normal
(d) There is no relationship between the two distributions.

Multiple Choice Test Bank Questions No Feedback – Chapter 4

Correct answers denoted by an asterisk.

1. Consider a standard normally distributed variable, a t-distributed variable with

d degrees of freedom, and an F-distributed variable with (1, d) degrees of
freedom. Which of the following statements is FALSE?
(a) The standard normal is a special case of the t-distribution, the square of which
is a special case of the F-distribution
(b) * Since the three distributions are related, the 5% critical values from each will
be the same
(c) Asymptotically, a given test conducted using any of the three distributions will
lead to the same conclusion
(d) The normal and t- distributions are symmetric about zero while the F-
distribution takes only positive values.

2. If our regression equation is y = Xβ + u, where we have T observations and k

regressors, what will be the dimension of b̂ using the standard matrix notation
(a) T × k
(b) T × 1
(c) * k × 1
(d) k × k.

Question 3 refers to the following regression estimated on 64 observations:

yt = β1 + β2X2t + β3X3t + β4X4t + ut

3. Which of the following null hypotheses could we test using an F-test?

(i) β2 = 0
(ii) β2 = 1 and β3 + β4 = 1
(iii) β3β4 = 1
(iv) β2 -β3 -β4 = 1.

(a) (i) and (ii) only

(b) (ii) and (iv) only
(c) (i), (ii), (iii), and (iv)
(d)* (i), (ii), and (iv) only.

For Question 4, you are given the following data

é 1.3 2.1 - 1.4ù é- 1.6ù

( X ' X ) = ê 2.1 0.8 1.9 ú,( X ' y ) = êê 2.9 úú,
-1 ê ú
êë- 1.4 1.9 3.4 úû êë 0.8 úû
s 2 = 0.86, T = 103

The regression equation is

yt = β1 + β2X2t + β3X3t + ut

4. Which of the following is the correct value for b̂ 1 ?

(a) * 2.89
(b) 1.30
(c) 0.84
(d) We cannot determine the value of b̂ 1 from the information given in the question.

5. Consider the following regression estimated using 84 observations:

yt = β1 + β2X2t + β3X3t + β4X4t + ut

Suppose that a researcher wishes to test the null hypothesis: β2 = 1 and β3 + β4 = 1.

The TABULATED value of the F-distribution that we would compare the result of
testing this hypothesis with at the 10% level would be approximately
(a) 19.48
(b) 2.76
(c) * 2.37
(d) 3.11.

6. What is the relationship, if any, between t-distributed and F-distributed random

variables?
(a) A t-variate with z degrees of freedom is also an F(1, z)
(b) * The square of a t-variate with z degrees of freedom is also an F(1, z)
(c) A t-variate with z degrees of freedom is also an F(z, 1)
(d) There is no relationship between the two distributions.

7. Which one of the following statements must hold for EVERY CASE
concerning the residual sums of squares for the restricted and unrestricted
regressions?
(a) URSS > RRSS
(b) URSS ≥ RRSS
(c) RRSS > URSS
(d) * RRSS ≥ URSS.

8. Which one of the following is the most appropriate as a definition of R2 in the

context that the term is usually used?
(a) It is the proportion of the total variability of y that is explained by the model
(b) * It is the proportion of the total variability of y about its mean value that is
explained by the model
(c) It is the correlation between the fitted values and the residuals
(d) It is the correlation between the fitted values and the mean.

9. Suppose that the value of R2 for an estimated regression model is exactly one.
Which of the following are true?
(i) All of the data points must lie exactly on the line
(ii) All of the residuals must be zero
(iii) All of the variability of y about its mean has been explained by the model
(i) The fitted line will be horizontal with respect to all of the explanatory
variables.

(a) (ii) and (iv) only

(b) (i) and (iii) only
(c) * (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).
10. Consider the following two regressions
yt = b1 + b 2 x2t + b 3 yt -1 + ut
Dyt = g 1 + g 2 x2t + g 3 yt -1 + ut
Which of the following statements are true?
(i) The RSS will be the same for the two models
(ii) The R2 will be the same for the two models
(iii) The adjusted R2 will be different for the two models
(iv) The regression F-test will be the same for the two models.

(a) (ii) and (iv) only

(b) * (i) and (iii) only
(c) (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).

11. Which of the following are often considered disadvantages of the use of
adjusted R2 as a variable addition/variable deletion rule?
(i) Adjusted R2 always rises as more variables are added
(ii) Adjusted R2 often leads to large models with many marginally significant or
marginally insignificant variables
(iii) Adjusted R2 cannot be compared for models with different explanatory
variables
(iv) Adjusted R2 cannot be compared for models with different explained
variables.

(a) * (ii) and (iv) only

(b) (i) and (iii) only
(c) (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).

12. Which of these is a mathematical expression of the residual sum of squares?

(I) uˆ ' uˆ
(II) [u1u2 ...uT ]
ˆˆ ˆ

(III) uˆ1 + uˆ2 + ... + uˆT

(a) * I only
(b) I and II only
(c) I and III only
(d) I, II and III.

13. If you are interested in conducting a multiple hypotheses test to determine

whether b 2 and b3 are both unity for a regression y = b1 + b2 x2 + b3 x3 + b4 x4 + u ,
what would the restricted regression be?
(a) y = b1 + b4 x4 + u
(b) ( y - x2 ) = b1 + b2 + b3 x3 + b4 x4 + u
(c)* ( y - x2 - x3 ) = b1 + b4 x4 + u
(d) ( y - x4 ) = b1 + b2 x2 + b3 x3 + u .

14. What would the restricted regression be if you are interested in testing the null
hypothesis H 0 : b2 = 0 and b3 = 0 against the alternative hypothesis H1 : b 2 ¹ 0 or
b3 ¹ 0 for a regression y = b1 + b2 x2 + b3 x3 + b4 x4 + u ,?

(a)* y = b1 + b4 x4 + u
(b) ( y - x2 ) = b1 + b2 + b3 x3 + b4 x4 + u
(c) ( y - x2 - x3 ) = b1 + b4 x4 + u
(d) ( y - x4 ) = b1 + b2 x2 + b3 x3 + u .

15. Assuming that the restricted sum of squares of the restricted regression in
Question 14 is 436.1 and the unrestricted sum of squares is 397.2, what would the
conclusion of the hypothesis test be? (The significance level is 5%.)
(a)* Reject the null hypothesis
(b) Do not reject the null hypothesis
(c) Reject the alternative hypothesis
(d) Cannot say.
16. Which of these statements is a characteristic of the stepwise regression
procedure?
(I) It chooses the jointly most ‘important’ explanatory variable from a set of
candidate variables
(II) It can start with no variables in the regression and then it selects first the
variable with the lowest p-value
(III) It can start with no variables in the regression and then it selects first the
variable with the highest p-value
(a) I only
(b) II only
(c) III only
(d)* Both I and II.

17. Trying many variables in a regression without basing the selection of

candidate variables on a financial or economic theory is popularly referred to as
(a) Data fitting
(b) Data clipping
(c)* Data mining
(d) None of the above.

18. Why is R2 a commonly used and perhaps better measure of how well a
regression model fits the data than the residual sum of squares (RSS)?
(a) The RSS is often too large
(b) The RSS does not depend on the scale of the dependent variable whereas the
R2 does
(c)* The RSS depends on the scale of the dependent variable whereas the R2 does
not
(d) The RSS depends on the scale of the independent variable whereas the R2 does
not.

Use the following to answer Questions 19 and 20.

Assuming you have two regression models yt = a1 + a 2 x2t + a3 x3t + ut and
yt = b1 + b 2 x4t + b3 x5t + vt .

19. How can the two models be validly compared to determine the model that
better represents the data yt?
(a) By observing their respective R2
(b) By observing their respective Adjusted R2
(c) By estimating an encompassing or hybrid model
(d)* All of the above.
20. What is the relevant encompassing model required to compare the two
regression models?
(a)* yt = g 1 + g 2 x2t + g 3 x3t + g 4 x4t + g 5 x5t + wt
(b) yt = g 1 + g 2 x2t + g 3 x3t + g 5 x5t + wt
(c) g 1 = yt + g 2 x2t + g 3 x3t + g 4 x4t + g 5 x5t + wt
(d) Encompassing models cannot be used to compare these specifications.

21. Which of these statements is NOT true about quantile regressions?

(a) No distributional assumptions are required to optimally estimate the parameters
(b) It is a non-parametric technique
(c)* It is a parametric technique
(d) The response variable is usually assumed to be independently distributed and
homoscedastic.

Multiple Choice Test Bank Questions No Feedback – Chapter 5

Correct answers denoted by an asterisk.

2. A researcher conducts a Breusch–Godfrey test for autocorrelation using 3 lags

of the residuals in the auxiliary regression. The original regression contained 5
regressors including a constant term, and was estimated using 105 observations.
What is the critical value using a 5% significance level for the LM test based on
T R2 ?
(a) 1.99
(b) 2.70
(c) * 7.81
(d) 8.56.

2. Which of the following would NOT be a potential remedy for the problem of
multicollinearity between regressors?
(a) Removing one of the explanatory variables
(b) * Transforming the data into logarithms
(c) Transforming two of the explanatory variables into ratios
(d) Collecting higher frequency data on all of the variables.

3. Which of the following conditions must be fulfilled for the Durbin–Watson test
to be valid?
(i) The regression includes a constant term
(ii) The regressors are non-stochastic
(iii) There are no lags of the dependent variable in the regression
(iv) There are no lags of the independent variables in the regression.
(a)* (i), (ii), and (iii) only
(b) (i) and (ii) only
(c) (i), (ii), (iii), and (iv)
(d) (i), (ii), and (iv) only.

4. If the residuals of a regression on a large sample are found to be heteroscedastic

which of the following might be a likely consequence?
(i) The coefficient estimates are biased
(ii) The standard error estimates for the slope coefficients may be too small
(iii) Statistical inferences may be wrong.

(a) (i) only

(b) * (ii) and (iii) only
(c) (i), (ii), and (iii)
(d) (i) and (ii) only.
5. The value of the Durbin–Watson test statistic in a regression with 4 regressors
(including the constant term) estimated on 100 observations is 3.6. What might we
suggest from this?
(a) The residuals are positively autocorrelated
(b) * The residuals are negatively autocorrelated
(c) There is no autocorrelation in the residuals
(d) The test statistic has fallen in the intermediate region.

6. Which of the following is NOT a good reason for including lagged variables in a
regression?
(a) Slow response of the dependent variable to changes in the independent variables
(b) Over-reactions of the dependent variables
(c) The dependent variable is a centred moving average of the past 4 values of the
series
(d) * The residuals of the model appear to be non-normal.

7. What is the long-run solution to the following dynamic econometric model?

Δyt = β1 + β2ΔX2t + β3ΔX3t + ut
(a) y = β1 + β2X2 + β3X3
(b) yt = β1 + β2X2t + β3X3t
(c) y = - (β2/ β1) X2 - (β3 / β1)X3
(d) * There is no long-run solution to this equation.

8. Which of the following would you expect to be a problem associated with adding
lagged values of the dependent variable into a regression equation?
(a) * The assumption that the regressors are non-stochastic is violated
(b) A model with many lags may lead to residual non-normality
(c) Adding lags may induce multicollinearity with current values of variables
(d) The standard errors of the coefficients will fall as a result of adding more
explanatory variables.

9. A normal distribution has coefficients of skewness and excess kurtosis which are,
respectively,
(a) * 0 and 0
(b) 0 and 3
(c) 3 and 0
(d) Will vary from one normal distribution to another.

10. Which of the following would probably NOT be a potential ‘cure’ for non-
normal residuals?
(a) * Transforming two explanatory variables into a ratio
(b) Removing large positive residuals
(c) Using a procedure for estimation and inference which did not assume normality
(d) Removing large negative residuals.

11. What would be the consequences for the OLS estimator if autocorrelation is
present in a regression model but ignored?
(a) It will be biased
(b) It will be inconsistent
(c) * It will be inefficient
(d) All of (a), (b), and (c) will be true.

12. If OLS is used in the presence of heteroscedasticity, which of the following

will be likely consequences?
(i) Coefficient estimates may be misleading
(ii) Hypothesis tests could reach the wrong conclusions
(iii) Forecasts made from the model could be biased
(iv) Standard errors may inappropriate.

(a) * (ii) and (iv) only

(b) (i) and (iii) only
(c) (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).

13. If a residual series is negatively autocorrelated, which one of the following is

the most likely value of the Durbin–Watson statistic?
(a) Close to zero
(b) Close to two
(c) * Close to four
(d) Close to one.

14. If the residuals of a model containing lags of the dependent variable are
autocorrelated, which one of the following could this lead to?
(a) Biased but consistent coefficient estimates
(b) * Biased and inconsistent coefficient estimates
(c) Unbiased but inconsistent coefficient estimates
(d) Unbiased and consistent but inefficient coefficient estimates.

15. Which one of the following is NOT a symptom of near multicollinearity?

(a) The R2 value is high
(b) The regression results change substantively when one particular variable is
deleted
(c) * Confidence intervals on parameter estimates are narrow
(d) Individual parameter estimates are insignificant.
16. Which one of the following would be the most appropriate auxiliary regression
for a Ramsey RESET test of functional form?
(a) * yt = a 0 + a1 yˆ t + vt
2

(b) yt = a0 + a1 x2t + a 2 x3t + a 4 x2t + a5 x3t + a6 x2t x3t + vt

2 2 2

(c) uˆt = a 0 + a1 yˆ t + vt
2 2

(d) ut = a 0 + a1 x2t + a 2 x3t + a 4 x2 t + a 5 x3t + a 6 x2t x3t + vt .

2 2

17. If a regression equation contains an irrelevant variable, the parameter estimates

will be
(a) * Consistent and unbiased but inefficient
(b) Consistent and asymptotically efficient but biased
(c) Inconsistent
(d) Consistent, unbiased and efficient.

18. Put the following steps of the model-building process in the order in which it
would be statistically most appropriate to do them:
(i) Estimate model
(ii) Conduct hypothesis tests on coefficients
(iii) Remove irrelevant variables
(iv) Conduct diagnostic tests on the model residuals.

(a) (i) then (ii) then (iii) then (iv)

(b) (i) then (iv) then (ii) then (iii)
(c) * (i) then (iv) then (iii) then (ii)
(d) (i) then (iii) then (ii) then (iv).

19. Test statistics for the LM test and the Wald test are usually constructed to
follow a
(a)* χ2 distribution and F-distribution, respectively
(b) χ2 distribution and t-distribution, respectively
(c) F-distribution and χ2 distribution, respectively
(d) t-distribution and χ2 distribution, respectively.

20. Which of these statements is true?

(I) The F-distribution has 2 degrees of freedom parameters
(II) Asymptotically, the LM test and the Wald test are equivalent
(III) The results from the LM and Wald tests may differ somewhat in small
samples
(IV) The F-distribution is a special case of the t-distribution.

(a) I only
(b) I and II
(c)* I, II, and III
(d) I, II, III, and IV.

21. The assumption of homoscedasticity can be written mathematically as

(a)* var ( ut ) = s < ¥
2

(b) var ( ut ) ¹ s < ¥

2

(c) var ( ut ) £ s < ¥

2

(d) var ( ut ) ³ s < ¥ .

2

22. Assuming you are interested in conducting a Goldfeld–Quandt test at a 5%

significance level and the regression model is estimated on each sub-sample with
residual variances s1 = 0.15 and s2 = 0.14 , T1 = 12, T2 = 14 and k = 2 . What would
2 2

your conclusion be?

(a) Do not reject the null hypothesis of heteroscedasticity
(b) Reject the null hypothesis of homoscedasticity
(c) Reject the null hypothesis of heteroscedasticity
(d)* Do not reject the null hypothesis of homoscedasticity.

23. Which of these is a test for heteroscedasticity?

(a) Breusch–Godfrey test
(b)* White test
(c) Bera–Jarque test
(d) Breusch–Jagan test.

24. Which of these is NOT a viable ‘solution’ for heteroscedasticity?

(a) Using generalised least squares if the form of heteroscedasticity is known
(b) Transforming the variables into logs
(c) Using heteroscedasticity-consistent standard error estimates
(d)* Taking the first differences of the series.
 (A) (B)

25. The graphs above are time series plots of residuals from two separate
regressions. Which of these combinations is true?
(a)* A shows negative autocorrelation and B shows positive autocorrelation
(b) A shows positive autocorrelation and B shows negative autocorrelation
(c) A shows heteroscedasticity and B shows homoscedasticity
(d) A shows homoscedasticity and B shows heteroscedasticity.

26. Assuming a researcher runs the following regression ut = rut -1 + vt where ut is

residual from a regression. If the researcher conducts a hypothesis test with null
hypothesis of H 0 : r = 0 against an alternative hypothesis of H1 : r ¹ 0 , what type
of test is he or she conducting?
(a) Test for heteroscedasticity
(b)* Test for autocorrelation
(c) Test for non-normality
(d) Test for homoscedasticity.

27. Assuming the researcher now runs the following regression

ut = r1ut -1 + r2ut -2 + ... + r r ut -r + vt where ut is residual from a regression. If the

researcher conducts a test with a null hypothesis of H 0 : r1 = 0 and r2 = 0 and ...

and r r = 0 against an alternative hypothesis of H1 : r1 ¹ 0 or r2 ¹ 0 or ... or r r ¹ 0,
what type of test is he or she conducting?
(a) Test for rth order of heteroscedasticity
(b)* Test for rth order of autocorrelation
(c) Test for rth order of non-normality
(d) Test for rth order of homoscedasticity.
28. Which of these is not a consequence of ignoring autocorrelation if it is
present?
(a) The coefficient estimates derived using OLS are inefficient
(b) Standard error estimates are inappropriate
(c)* The coefficient estimates derived using OLS are biased
(d) The coefficient estimates derived using OLS are not the best linear unbiased
estimators.

29. Which of these is a viable solution to the problem of multicollinearity?

(I) Ignore it
(II) Drop one of the collinear variables
(III) Transform the highly correlated variables into a ratio
(IV) Take the logs of the variables

(a) I only
(b) I and II only
(c)* I, II, and III only
(d) I, II, III, and IV.
30. Which of the following statements are true about parameter stability tests?
(I) Parameter stability tests test the assumption that the estimated parameters of a
model are constant for the entire sample
(II) Chow test and predictive failure tests are two types of parameter stability tests
(III) Backward and forward predictive failure tests are two types of parameter
stability tests
(IV) Parameter stability tests examine violations of the classical linear regression
model assumptions.

(a) I only
(b) I and II only
(c)* I, II, and III only
(d) I, II, III, and IV.

31. Simultaneous equations bias is a situation where

(a)* There is a two-way causal relationship between the explanatory and explained
variable
(b) There is a two-way causal relationship between two selected explanatory
variables
(c) There is a two-way causal relationship between two selected independent
variables
(d) There is a two-way causal relationship between the residuals of two regression
models.

Multiple Choice Test Bank Questions No Feedback – Chapter 6

Correct answers denoted by an asterisk.

1. Consider the following model estimated for a time series

yt = 0.3 + 0.5 yt-1 - 0.4 εt-1 + εt
where εt is a zero mean error process.
What is the (unconditional) mean of the series, yt ?

(a) * 0.6
(b) 0.3
(c) 0.0
(d) 0.4.

2. Consider the following single exponential smoothing model:

St = α Xt + (1-α) St-1
You are given the following data:
â =0.1, Xt=0.5,St-1=0.2
If we believe that the true DGP can be approximated by the exponential smoothing
model, what would be an appropriate 2-step-ahead forecast for X? (i.e., a forecast
of Xt+2 made at time t)

(a) 0.2
(b) * 0.23
(c) 0.5
(d) There is insufficient information given in the question to form more than a one-
step- ahead forecast.

3. Consider the following MA(3) process

yt = 0.1 + 0.4ut-1 + 0.2ut-2 – 0.1ut-3 + ut
What is the optimal forecast for yt, 3 steps into the future (i.e., for time t+2 if all
information until time t–1 is available), if you have the following data?
ut-1 = 0.3; ut-2 = –0.6; ut-3 = –0.3

(a) 0.4
(b) 0.0
(c) * 0.07
(d) –0.1.

4. Which of the following sets of characteristics would usually best describe an

autoregressive process of order 3 (i.e., an AR(3))?

(a) * A slowly decaying acf, and a pacf with 3 significant spikes

(b) A slowly decaying pacf and an acf with 3 significant spikes
(c) A slowly decaying acf and pacf
(d) An acf and a pacf with 3 significant spikes.

5. A process, xt, which has a constant mean and variance, and zero autocovariance
for all non-zero lags is best described as

(a) * A white noise process

(b) A covariance stationary process
(c) An autocorrelated process
(d) A moving average process.

6. Which of the following conditions must hold for the autoregressive part of an
ARMA model to be stationary?

(a) * All roots of the characteristic equation must lie outside the unit circle
(b) All roots of the characteristic equation must lie inside the unit circle
(c) All roots must be smaller than unity
(d) At least one of the roots must be bigger than one in absolute value.

7. Which of the following statements are true concerning time-series forecasting?

(i) All time-series forecasting methods are essentially extrapolative
(ii) Forecasting models are prone to perform poorly following a structural break in
a series
(iii) Forecasting accuracy often declines with prediction horizon
(iv) The mean squared errors of forecasts are usually very highly correlated with the
profitability of employing those forecasts in a trading strategy.

(a) (i), (ii), (iii), and (iv)

(b) * (i), (ii), and (iii) only
(c) (ii), (iii) only
(d) (ii) and (iv) only.

8. If a series, yt, follows a random walk (with no drift), what is the optimal 1-step-
ahead forecast for y?
(a) * The current value of y
(b) Zero
(c) The historical unweighted average of y
(d) An exponentially weighted average of previous values of y.

9. Consider a series that follows an MA(1) with zero mean and a moving average
coefficient of 0.4. What is the value of the autocorrelation function at lag 1?
(a) 0.4
(b) 1
(c) *0.34
(d) It is not possible to determine the value of the autocovariances without
knowing the disturbance variance.

10. Which of the following statements are TRUE?

(i) An MA(q) can be expressed as an AR(infinity) if it is invertible
(ii) An AR(p) can be written as an MA(infinity) if it is stationary
(iii) The (unconditional) mean of an ARMA process will depend only on the
intercept and on the AR coefficients and not on the MA coefficients
(iv) A random walk series will have zero pacf except at lag 1.

(a) (ii) and (iv) only

(b) (i) and (iii) only
(c) (i), (ii), and (iii) only
(d) * (i), (ii), (iii), and (iv).
11. Consider the following picture and suggest the model from the following list
that best characterises the process:

(a) An AR(1)
(b) An AR(2)
(c) * An ARMA(1,1)
(d) An MA(3).

The acf is clearly declining very slowly in this case, which is consistent with their
being an autoregressive part to the appropriate model. The pacf is clearly
significant for lags 1 and 2, but the question is: does it them become
insignificant for lags 2 and 4, indicating an AR(2) process, or does it
remain significant, which would be more consistent with a mixed ARMA
process? Well, given the huge size of the sample that gave rise to this acf
and pacf, even a pacf value of 0.001 would still be statistically significant.
Thus an ARMA process is the most likely candidate, although note that it
would not be possible to tell from the acf and pacf which model from the
ARMA family was more appropriate. The DGP for the data that generated
this plot was y_t = 0.9 y_(t–1) – 0.3 u_(t–1) + u_t.

12. Which of the following models can be estimated using ordinary least squares?
(i) An AR(1)
(ii) An ARMA(2,0)
(iii) An MA(1)
(iv) An ARMA(1,1).
(a) (i) only
(b) * (i) and (ii) only
(c) (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).

13. If a series, y, is described as ‘mean-reverting’, which model from the following

list is likely to produce the best long-term forecasts for that series y?
(a) A random walk
(b) * The long term mean of the series
(c) A model from the ARMA family
(d) A random walk with drift.

14. Consider the following AR(2) model. What is the optimal 2-step-ahead
forecast for y if all information available is up to and including time t, if the values
of y at time t, t-1 and t-2 are –0.3, 0.4 and –0.1, respectively, and the value of u at
time t-1 is 0.3?
yt = –0.1 + 0.75yt-1 – 0.125yt-2 + ut

(a) –0.1
(b) 0.27
(c) * –0.34
(d) 0.30.

15. What is the optimal three-step-ahead forecast from the AR(2) model given in
Question 14?
(a) –0.1
(b) 0.27
(c) –0.34
(d) * –0.31.

16. Suppose you had to guess at the most likely value of a one hundred-step-ahead
forecast for the AR(2) model given in Question 14 – what would your forecast be?
(a) -0.1
(b) 0.7
(c) * –0.27
(d) 0.75.

17. Which of these is NOT a consequence of working with non-stationarity

variables?
(a) Shocks will be persistent
(b) Unjustifiably high R2
(c) The standard assumptions for asymptotic analysis will be invalid
(d)* It leads to data mining.

18. Three characteristics of a weakly stationary process are

(I) E ( yt ) = µ
(II) E ( yt - µ )( yt - µ ) = s < ¥
2

(III) E ( yt1 - µ )( yt 2 - µ ) = g t 2-t1 "t1 , t2 .

What do the mathematical expressions I, II, and III imply?

(a) Constant variance, constant mean, and constant autocovariance, respectively
(b) Constant autocovariance structure, constant mean, and constant variance,
respectively
(c) Constant mean, constant autocorrelation, and constant autocovariance,
respectively
(d)* Constant mean, constant variance, and constant autocovariance structure,
respectively.

Use the following to answer Questions 19 and 20. Suppose that you have
estimated the first five autocorrelation coefficients using a series of length 81
observations and found them to be
Lag 1 2 3 4 5
Autocorrelation coefficient 0.412 -0.205 -0.332 0.005 0.543

19. Which autocorrelation coefficients are significantly different from zero at the
5% level?
(a) The first and fifth autocorrelation coefficient
(b) The first, second, third, and fifth autocorrelation coefficient
(c)* The first, third, and fifth autocorrelation coefficient
(d) The second and fourth autocorrelation coefficient.

20. What is the appropriate Box–Pierce test statistic?

(a) 4.78
(b)* 47.83
(c) 59.05
(d) 5.91.
21. Consider the following MA(2) process yt = ut + q1ut -1 + q2ut -2 where the errors
follow a standard normal distribution. What is the variance of yt ?
E éu2 + q12ut2-1 + q 22ut2-2 ùû
(a) ë t
(b) s + q1 s + q 2 s
2 2 2 2 2

(c) 1 + q 1 + q 2
2 2

(d)* All of the above.

22. A model where the current value of a variable depends upon only the values
that the variable took in previous periods plus an error term is called
(a)* An autoregressive model
(b) An autoregressive moving average model
(c) An autoregressive integrated moving average model
(d) A periodic lag model.

23. Is the following process yt = 3 yt -1 - 2.75 yt -2 + 0.75 yt -3 + ut stationary?

(a) Yes
(b)* No
(c) Partly stationary
(d) Cannot say.

24. What type of a process is

yt = ut + f1 yt -1 + f2 yt -2 + ... + f p yt - p + q1ut -1 + q 2ut -2 + ... + q qut -q + ut
?
(a) An autoregressive model
(b)* An autoregressive moving average model
(c) An autoregressive integrated moving average model
(d) A periodic lag model.

25. Which of these is an appropriate way to determine the order of an ARMA

model required to capture the dynamic features of a given data?
(a) Graphically plotting the time series of the data
(b) Determining the number of parameters that maximises the information criteria
(c)* Determining the number of parameters that minimises the information criteria
(d) None of the above.

26. A recursive forecasting framework is one where

(a)* The initial estimation date is fixed but additional observations are added one
at a time to the estimation period
(b) The length of the in-sample period used to estimate the model is fixed so that
the start date and end date successively increase by one observation
(c) The initial estimation date changes as additional observations are added one at
a time to the estimation period
(d) The length of the out-of-sample period used to estimate the model is fixed so
that the start date and end date successively increase by one observation.

27. A rolling window forecasting framework is one where

(a) The initial estimation date is fixed but additional observations are added one at
a time to the estimation period
(b)* The length of the in-sample period used to estimate the model is fixed so that
the start date and end date successively increase by one observation
(c) The initial estimation date changes as additional observations are added one at
a time to the estimation period
(d) The length of the out-of-sample period used to estimate the model is fixed so
that the start date and end date successively increase by one observation.

Use the following to answer Questions 28 to 30.

A researcher is interested in forecasting the house price index in Country Z. The
observed price index values from 1996 to 2000 are 101, 103 104, 107 and 111.
The researcher uses two different forecasting models, A and B. The forecasts for
the price index using Model A are 100.5, 102.4, 103.2, 106 and 111 whilst the
forecast using Model B are 100.8, 102.2, 104, 104.2 and 112.1.

28. What are the closest to the mean squared errors for model A and B’s forecasts?
(a) 0.58 and 0.98, respectively
(b) 0.98 and 0.58, respectively
(c)* 0.45 and 1.95, respectively
(d) 1.95 and 0.45, respectively.

29. What are the closest to the mean absolute errors from models A and B?
(a)* 0.58 and 0.98, respectively
(b) 0.98 and 0.58, respectively
(c) 0.45 and 1.95, respectively
(d) 1.95 and 0.45, respectively.

30. Based on the MAE and MSE forecast evaluation metrics, which of these
statements are true?
(a)* Model A outperforms Model B at forecasting the house price index
(b) Model A underperforms Model B at forecasting the house price index
(c) Model A and Model B perform equally well at forecasting the house price
index
(d) We cannot tell which model does best.
 Multiple Choice Test Bank Questions No Feedback – Chapter 7

Correct answers denoted by an asterisk.

1. Which of the following are characteristics of vector autoregressive (VAR)

models?
(i) They are typically a-theoretical and data driven
(ii) They can easily lead to overfitting
(iii) All variables on the right hand side of the equation are pre-determined
(iv) Their interpretation is often difficult from a theoretical perspective.

(a) * (i), (ii), (iii), and (iv)

(b) (i), (ii), and (iv) only
(c) (i) and (ii) only
(d) (i) and (iv) only.

For Questions 2 and 3, consider the following set of simultaneous equations:

Y1t = a 0 + a 1Y2t + a 2Y3t + a 4 X 1t + u1t (1)
Y2t = b 0 + b 1Y1t + b 2 X 1t + b 3 X 2t + b 4 X 3t + u 2t (2)
Y3t = g 0 + g 1Y1t + u 3t ( 3)
Assume that the Y’s are endogenous and the X’s exogenous variables, and that the
error terms are uncorrelated.

2. Which of the following statement is true of equation (3)?

(a) According to the order condition, it is not identified

(b) According to the order condition, it is just identified
(c) * According to the order condition, it is over-identified
(d) There is insufficient information given in the question to determine whether the
equation is identified or not.

3. Estimation of equation (2) on its own using OLS would result in

(a) Consistent and unbiased coefficient estimates

(b) Consistent coefficient estimates which might be biased in small samples
(c) Inconsistent but unbiased coefficient estimates
(d) * Coefficient estimates that are neither unbiased nor consistent.

4. Which of the following statements is INCORRECT?

(a) Equations that are part of a recursive system can be validly estimated using OLS
(b) Unnecessary use of two-stage least squares (2SLS) – i.e., on a set of right hand
side variables that are in fact exogenous – will result in consistent but inefficient
coefficient estimates
(c) 2SLS is just a special case of instrumental variables (IV) estimation
(d) * 2SLS and indirect least squares (ILS) are equivalent for over-identified
systems.

5. Which of the following could be viewed as a disadvantage of the vector

autoregressive (VAR) approach to modelling?

(a) We do not need to specify which variables are endogenous and which are
exogenous
(b) Standard form VARs can be estimated equation-by-equation using OLS
(c) * VARs often contain a large number of terms
(d) VARs can be expressed using a very compact notation.

6. Consider the following bivariate VAR(2):

y1t = a 10 + a11 y1t -1 + a12 y1t -2 + a 13 y 2t -1 + a14 y 2t -2 + u1t
y 2t = a 20 + a 21 y1t -1 + a 22 y1t -2 + a 23 y 2t -1 + a 24 y 2t -2 + u 2t
Which of the following coefficient significances are required to be able to say that
y1 Granger-causes y2 but not the other way around?

(a) α13 and α14 significant; α21 and α22 not significant
(b) * α21 and α22 significant; α13 and α14 not significant
(c) α21 and α23 significant; α11 and α13 not significant
(d) α11 and α13 significant; α21 and α23 not significant.

7. Which of the following statements is TRUE concerning VAR impulse response

functions?
(i) Impulse responses help the researcher to investigate the interactions between the
variables in the VAR
(ii) An impulse response analysis is where we examine the effects of applying unit
shocks to all of the variables at the same time
(iii) Impulse responses involve calculating the proportion of the total forecast error
variance of a given variable that is explained by innovations to each variable
(iv) If the ±2 standard error bars around the impulse responses for a given lag span
(i.e., include) the x-axis, it would be said that the response is statistically significant.

(a) (i), (ii), (iii), and (iv)

(b) (i), (ii), and (iii) only
(c) (i) only
(d) * (i) and (ii) only.
8. In the context of simultaneous equations modelling, which of the following
statements is TRUE concerning an exogenous variable?
(a) The values of exogenous variables are determined within the system
(b) * The exogenous variables are assumed to be fixed in repeated samples
(c) Reduced form equations will not contain any exogenous variables on the RHS
(d) Reduced form equations will contain only exogenous variables on the LHS.

9. Comparing the information criteria approach with the likelihood ratio test
approach to determining the optimal VAR lag length, which one of the following
statements is true?
(a) The choice of stiffness of penalty term will not affect the model choice
(b) The validity of information criteria relies upon normal residuals
(c) * Conducting a likelihood ratio test could lead to a sub-optimal model selection
(d) An application of the univariate information criteria to each equation will give
identical results to the application of a multivariate version of the criteria to all
of the equations jointly.

10. The second stage in two-stage least squares estimation of a simultaneous

system would be to
(a) Estimate the reduced form equations
(b) * Replace the endogenous variables that are on the RHS of the structural
equations with their reduced form fitted values
(c) Replace all endogenous variables in the structural equations with their reduced
form fitted values
(d) Use the fitted values of the endogenous variables from the reduced forms as
additional variables in the structural equations.

11. Which of these assumptions is violated when an equation is estimated using

OLS when it is in fact part of a simultaneous structural system?
(a) E ( X ' u ) = 0
(b)* E ( X ' u ) ¹ 0

(c)
( )
E ( X ' X ) X 'u = 0
-1

(d) None of the above.

12. A variable x is defined as ________ if its value is determined outside of the

equation or system of equations. What is the blank?
(a) Endogenous
(b)* Exogenous
(c) Homogeneous
(d) Heterogeneous.
13. Which of these is not an appropriate method of estimating equations that are
from a simultaneous system?
(a) Indirect least squares
(b) Two-stage least squares
(c)* Aggregate least squares
(d) Instrumental variables.
14. Which of these statements is true about vector autoregressive models?
(I) They allow the value of a variable to depend on more than just its own lags
(II) All variables are endogenous
(III) The researcher does not need to specify which variables are endogenous or
exogenous
(IV) All variables are exogenous

(a) I only
(b) I and II only
(c)* I, II, and III only
(d) I, II, III, and IV.

15. Which of these is an approach used to determine the appropriate lag lengths of
VAR models?
(a) Graphically plotting the time series of the data
(b) Selecting the number of lags that maximises the information criteria
(c)* Selecting the number of lags that minimises the information criteria
(d) None of the above.

16. Assuming that you have a VAR model with 2 variables (A and B) including
many lags, how can you test whether A cause Granger-causes changes in B?
(a) By observing if the differences in correlation between A and B are statistically
significant
(b)* Impose restrictions that all the coefficients of the lags of A are equal to 0 in
the equation for B of the VAR model and test the joint hypothesis within the F-test
framework
(c) Impose restrictions that all the coefficients of the lags of B are equal to 0 in the
equation for A of the VAR model and test the joint hypothesis within the F-test
framework
(d) None of the above.

17. Impulse responses:

(a)* Trace out the responsiveness of the dependent variables in the VAR to shocks
to each of the variables
(b) Are a different term for variance decompositions
(c) Trace out the responsiveness of the residuals in the VAR to shocks to each of
the variables
(d) Give the proportion of the movements in the dependent variables that are due
to their own shocks versus shocks to other variables.

18. Variance decompositions

(a) Trace out the responsiveness of the dependent variables in the VAR to shocks
to each of the variables
(b) Will always give the same conclusions as impulse responses
(c) Trace out the responsiveness of the residuals in the VAR to shocks to each of
the variables
(d)* Give the proportion of the movements in the dependent variables that are due
to their own shocks versus shocks to other variables.

Multiple Choice Test Bank Questions No Feedback – Chapter 8

Correct answers denoted by an asterisk.

1. Which of the following are probably valid criticisms of the Dickey–Fuller

methodology?
(i) The tests have a unit root under the null hypothesis and this may not be rejected
due to insufficient information in the sample
(ii) The tests are poor at detecting a stationary process with a unit root close to the
non-stationary boundary
(iii) The tests are highly complex to calculate in practice
(iv) The tests have low power in small samples.

(a) (i), (ii), (iii), and (iv)

(b) * (i), (ii), and (iv) only
(c) (i) and (iii) only
(d) (ii) only.

2. Which of the following are problems associated with the Engle–Granger

approach to modelling using cointegrated data?
(i) The coefficients in the cointegrating relationship are hard to calculate
(ii) This method requires the researcher to assume that one variable is the dependent
variable and the others are independent variables
(iii) The Engle–Granger technique can only detect one cointegrating relationship
(iv) The Engle-Granger technique does not allow the testing of hypotheses involving
the actual cointegrating relationship.

(a) (i), (ii), (iii), and (iv)

(b) * (ii), (iii), and (iv) only
(c) (ii), (iii) only
(d) (ii) and (iv) only.

3. Consider the following vector error correction (VECM) model:

Δyt = Πyt-5 + Γ1Δyt-1 + Γ2Δyt-2 + Γ3Δyt-3 + Γ4Δyt-4 + ut
where yt is a k × 1 vector of variables, and ut is a k × 1 vector of disturbances.
Which of the following statements is true of the VECM?
(a) Johansen’s test for cointegration centres on the rank of the matrix Γ1
(b) If the variables yt are cointegrated, Π will be of full rank
(c) If the rank of Π is zero, the variables are cointegrated
(d) * Provided that all of the series in y are non-stationary, the rank of Π can be at
most
k-1.

4. Consider the following matrix:

é 3 6ù
X =ê ú
ë1 2 û
What are its characteristic roots?
(a) * 5 and 0
(b) 5 and 5
(c) 3 and 2
(d) 0 and 0.

5. You have the following data for Johansen’s λmax rank test for cointegration
between 4 international equity market indices:
r λmax 5% Critical Value
0 40.03 30.26
1 26.81 23.84
2 13.42 17.72
3 8.66 10.71

How many cointegrating vectors are there?

(a) 0
(b) 1
(c) * 2
(d) 3.

6. Which criticism of Dickey–Fuller (DF)-type tests is addressed by stationarity

tests, such as the KPSS test?
(a) * DF tests have low power to reject the null hypothesis of a unit root, particularly
in small samples.
(b) DF tests are always over-sized.
(c) DF tests do not allow the researcher to test hypotheses about the cointegrating
vector
(d) DF tests can only find at most one cointegrating relationship.
7. Consider the following data generating process for a series yt:
yt = µ + 1.5 yt -1 + ut
Which one of the following most accurately describes the process for yt?

(a) A random walk with drift

(b) A non-stationary process
(c) A deterministic trend process
(d) * An explosive process.

8. Which one of the following best describes most series of asset prices?
(a) An independently and identically distributed (iid, i.e., ‘completely random’)
process
(b) * A random walk with drift
(c) An explosive process
(d) A deterministic trend process.

9. If there are three variables that are being tested for cointegration, what is the
maximum number of linearly independent cointegrating relationships that there
could be?
(a) 0
(b) 1
(c) *2
(d) 3.

10. If the number of non-zero eigenvalues of the pi matrix under a Johansen test is
2, this implies that
(a) * There are 2 linearly independent cointegrating vectors
(b) There are at most 2 linearly independent cointegrating vectors
(c) There are 3 variables in the system
(d) There are at least 2 linearly independent cointegrating vectors.

11. If a Johansen ‘max’ test for a null hypothesis of 1 cointegrating vectors is

applied to a system containing 4 variables, which eigenvalues would be used in the
test?
(a) The largest 1
(b) * The second largest
(c) The second smallest
(d) The smallest.
12. Consider the testing of hypotheses concerning the cointegrating vector(s)
under the Johansen approach. Which of the following statements is correct?
(a) If the restriction is (are) rejected, the number of cointegrating vectors will rise
(b) If the restriction(s) is (are) rejected, the number of eigenvalues will fall
(c) Whether the restriction is supported by the data or not, the eigenvalues are
likely to change at least slightly upon imposing the restriction(s)
(d) * All linear combinations of the cointegrating vectors are themselves
cointegrating vectors.

13. Which of these is a characteristic of a stationary series?

(a) Constant mean
(b) Constant autocovariances for each given lag
(c) Constant variance
(d)* All of the above.

14. Which of the following are consequences of using non-stationary data in

regressions?
(I) Shocks will be persistent
(II) It can lead to spurious regressions
(III) t-ratios will not follow a t-distribution
(IV) The F-statistic will not follow an F-distribution.

(a) I only
(b) I and II only
(c) I, II, and III only
(d)* I, II, III, and IV.

15. What is the impact of shocks to an AR(1) with no drift yt = µ + f yt -1 + ut if

f > 1?
(a) Shocks will gradually die away
(b) Shocks will persist in the system and never die away
(c) Shocks will start to increase after the next observation but gradually die away
(d)* Shocks become more and more influential as time goes on.

16. What is the impact of shocks to an AR(1) with no drift yt = µ + f yt -1 + ut if

f = 1?
(a) Shocks will gradually die away
(b)* Shocks persist in the system and never die away
(c) Shocks will start to increase after the next observation but gradually die away
(d) Shocks become more and more influential as time goes on.

17. To induce stationarity in a deterministic trend-stationary process

(a)* Regress the non-stationary series on the time trend and use the residuals
(b) Difference the series once
(c) Difference the series twice
(d) No action is necessary because the process is already stationary.
18. The plotted series in the following graph is an example of a:

(a) Stationary process

(b)* Deterministic trend process
(c) White noise prices
(d) Random walk with drift.

19. A researcher would like to test for a unit root in a series. She runs the
regression Dyt = y yt -1 + ut . What should her null hypothesis be assuming that she
adopts the Dickey–Fuller test approach?
(a)* y = 0
(b) y = 1
(c) y ¹ 0
(d) y ¹ 1.

20. Assuming the researcher in Question 19 would like to run an augmented

Dickey–Fuller test instead. What is the appropriate regression she would have to
run and the null hypothesis of the test?
p
Dyt = y yt -1 + å ai Dyt -i + ut
(a)* i =1 and y = 0 , respectively
p
Dyt = y yt -1 + å ai Dyt -i + ut
(b) i =1 and a = 1 , respectively
p
Dyt = y yt -1 + å ai Dyt -i + ut
(c) i =1 and y ¹ 0 , respectively
p
Dyt = y yt -1 + å ai Dyt -i + ut
(d) i =1 and y ¹ 1, respectively.

21. Two variables are said to be cointegrated if

(a) If the two variables are I(0) and a linear a combination of the two are I(1)
(b) If the two variables are I(1) and a linear a combination of the two are I(1)
(c) If the two variables are I(0) and a linear a combination of the two are I(0)
(d)* If the two variables are I(1) and a linear a combination of the two are I(0).

22. Assume that you are trying to model the relationship between house prices and
rents. If you find that both series are non-stationary and a linear combination of
the two series is stationary, which of the following is true?
(I) Regressing the levels of house prices on the levels of rents could lead to
spurious regressions
(II) House prices and rents are cointegrated
(III) An appropriate linear combination of house prices and rents is I(1)
(IV) House prices and rents are not cointegrated.

(a) I only
(b)* I and II only
(c) I, II, and III only
(d) I, II, III, and IV only.

Multiple Choice Test Bank Questions No Feedback – Chapter 9

Correct answers denoted by an asterisk.

1. Volatility clustering is
(a) The tendency for financial asset returns to have distributions that exhibit fat
tails
(b)* The tendency for financial asset return volatility to appear in bunches
(c) The tendency for volatility to rise more following a large price fall than
following a price rise of the same magnitude
(d) All of the above.

2. Which of the following is TRUE about ARCH and GARCH models?

(I) They are used for modelling and forecasting volatility
(II) They are non-linear models
(III) They can both be estimated using OLS
(IV) Series estimated using these models must have a unit root process.

(a) I only
(b)* I and II only
(c) I, II, and III only
(d) I, II, III, and IV.

3. Which of these cannot be used to test for non-linearity?

(a) Portmanteau tests
(b)* White test
(c) Ramsey’s RESET test
(d) The BDS test.

4. Which of the following statements are true regarding volatility:

(I) It measures the total risk of financial assets
(II) It can be used in computing value-at-risk
(III) It is a component of the Black–Scholes formula for deriving the prices of
traded options
(IV) It can be estimated using the variance of asset returns.

(a) I only
(b) I and II only
(c) I, II, and III only
(d)* I, II, III, and IV.
5. What are the names of the following models?
(I) s t = a 0 + a1ut -1
2 2

(II) s t = a 0 + a1ut -1 + bs t -1
2 2 2

(III) s t = a0 + a1ut -1 + a 2ut -2 + ... + a qut -q

2 2 2 2

(IV) s t = a0 + a1ut -1 + a 2ut -2 + ... + a put - p + b1s t -1 + b2s t -2 + ... + bqs t -q

2 2 2 2 2 2 2

(a) GARCH (1), ARCH (1,1), GARCH(q) and ARCH(p,q), respectively

(b)* ARCH(1), GARCH(1,1), ARCH(q) and GARCH(p,q), respectively
(c) ARCH(1), EGARCH(1,1), ARCH(q) and EGARCH(p,q), respectively
(d) EGARCH (1), ARCH(1,1), EGARCH (q) and ARCH(p,q), respectively.

6. What is an appropriate approach to testing for ‘ARCH effects’?

(a)* Run a regression, collect the residuals, regress the squared residuals on their
lags and conduct a hypothesis test to check whether the coefficients of the lagged
squared residuals are equal to zero
(b) Run a regression, collect the fitted values, regress the fitted values on their
squared lags and conduct a hypothesis test to check whether the coefficients of the
lagged squared fitted values are equal to zero
(c) Employ White’s test
(d) All of the above.

7. Which of these is an appropriate technique used in estimating models from the

GARCH family?
(a)* Maximum likelihood
(b) Instrumental variables
(c) Indirect least squares
(d) Ordinary least squares.

8. What are the steps required to estimate an ARCH/GARCH model?

(a) First specify the appropriate equations for the correlation and the variance, then
specify LLF and the computer will generate parameter values that maximise the
LLF
(b) First specify the appropriate equations for the median and the variance, then
specify LLF and the computer will generate parameter values that maximise the
LLF
(c)* First specify the appropriate equations for the mean and the variance, then
specify LLF and the computer will generate parameter values that maximise the
LLF
(d) None of the above.

9. GJR and EGARCH are types of GARCH models that allow for:
(a) An asymmetric response of returns to positive and negative shocks in the
dependent variable
(b) An asymmetric response of returns to positive and negative shocks to its
lagged values
(c) A symmetric response of volatility to positive and negative shocks
(d)* An asymmetric response of volatility to positive and negative shocks.

10. Assume that you have estimated a GJR model of monthly stock returns and
you obtain the following equations:
yt = 0.125
s t2 = 1.102 + 0.115ut2-1 + 0.641s t2-1 + 0.175ut2-1 I t -1
Suppose that s t -1 = 0.721, what would be the fitted conditional variance for time t
2

if uˆt -1 = 0.5 and then if uˆt -1 = -0.5?

(a) 1.62 and 1.67, respectively
(b) 1.64 and 1.59, respectively
(c)* 1.59 and 1.64, respectively
(d) 1.67 and 1.62, respectively.

11. Suppose that a researcher estimates a GARCH(1,1) model and obtains a log
likelihood function (LLF) value of 71.22. She is interested in testing whether an
ARCH(1) model is a better model at describing volatility. If she estimates a model
which imposes the necessary restrictions and obtains an LLF value of 68.21, what
would be the conclusion of her likelihood ratio test (assuming a 5% significance
level)?
(a) Statistical evidence suggesting that ARCH(1) is better than GARCH(1,1)
(b)* Statistical evidence suggesting that ARCH(1) is not better than GARCH(1,1)
(c) Statistical evidence suggesting that GARCH(1,1) is better than ARCH(1)
(d) We cannot say because we would need to know the number of observations.

12. What would typically be the shape of the news impact curve for a series that
exactly followed a GARCH(1,1) process?
(a) It would be asymmetric, with a steeper curve on the left than the right
(b) It would be asymmetric, with a steeper curve on the right than the left
(c) * It would be symmetric about zero
(d) It would be discontinuous about zero.

13. Which of the following are NOT features of an IGARCH(1,1) model?

(i) Forecasts of the conditional variance will converge upon the unconditional
variance as the horizon tends to infinity
(ii) The sum of the coefficients on the lagged squared error and the lagged
conditional variance will be unity
(iii) Forecasts of the conditional variance will decline gradually towards zero as
the horizon tends to infinity
(iv) Such models are never observed in reality.

(a) * (ii) only

(b) (ii) and (iv) only
(c) (ii), (iii), and (iv) only
(d) (i), (ii), (iii), and (iv)
.

14. Which of the following would represent the most appropriate definition for
implied volatility?
(a) * It is the volatility of the underlying asset’s returns implied from the price of a
traded option and an option pricing model
(b) It is the volatility of the underlying asset’s returns implied from a statistical
model such as GARCH
(c) It is the volatility of an option price implied from a statistical model such as
GARCH
(d) It is the volatility of an option price implied from the underlying asset
volatility.

15. Suppose that a researcher wanted to obtain an estimate of realised (‘actual’)

volatility. Which one of the following is likely to be the most accurate measure of
volatility of stock returns for a particular day?
(a) The price range (high minus low) on that day
(b) The squared return on that day
(c) * The sum of the squares of hourly returns on that day
(d) The squared return on the previous day.

16. Which of the following is the most plausible test regression for determining
whether a series y contains ‘ARCH effects’?
y 2 = a 0 + a1 y t -1+a 2 y t - 2 +a 3 y t - 3 +a 4 y t - 4 +a 5 y t - 5 +ut
(a) t
* yt = a0 + a1 yt -1 +a 2 yt - 2 +a3 yt -3 +a4 yt - 4 +a5 yt -5 +ut
2 2 2 2 2 2
(b)
yt = a0 + a1 yt -1 +a 2 yt - 2 +a3 yt -3 +a 4 yt - 4 +a5 yt -5 +ut
2 2 2 2 2
(c)
yt = a0 + a1 yt -1 +a 2 yt - 2 +a3 yt -3 +a 4 yt - 4 +a5 yt -5 +ut .
2 3 4 5 6
(d)

17. Consider the following conditional variance equation for a GJR model.
 2
ht = α0 + α1 ut -1 +βht-1+γut-12It-1
where It-1 = 1 if ut-1 < 0
= 0 otherwise
For there to be evidence of a leverage effect, which ONE of the following
conditions must hold?
(a) α0 positive and statistically significant
(b) * γ positive and statistically significant
(c) γ statistically significantly greater than α0
(d) α1+β statistically significantly less than γ .
18. Consider the three approaches to conducting hypothesis tests under the
maximum likelihood framework. Which of the following statements are true?
(i) The Wald test is based on estimation only under the null hypothesis
(ii) The likelihood ratio test is based on estimation under both the null and the
alternative hypotheses
(iii) The Lagrange multiplier test is based on estimation under the alternative
hypothesis only
(iv) The usual t- and F-tests are examples of Wald tests.

(a) * (ii) and (iv) only

(b) (i) and (iii) only
(c) (i), (ii), and (iv) only
(d) (i), (ii), (iii), and (iv).

19. Which one of the following problems in finance could not be usefully
addressed by either a univariate or a multivariate GARCH model?
(a) Producing option prices
(b) Producing dynamic hedge ratios
(c) Producing time-varying beta estimates for a stock
(d) * Producing forecasts of returns for use in trading models
(e) Producing correlation forecasts for value at risk models.

Multiple Choice Test Bank Questions No Feedback – Chapter 10

Correct answers denoted by an asterisk.

1. Threshold autoregressive and Markov switching models:

(a)* Allow us to potentially capture regime switches in a dependent variable
(b) Forecast correlations of two distinct series
(c) Maximise the threshold of autoregressive models
(d) All of the above.

To check for seasonality (day-of-the-week effect) in stock returns of South Korea,

Malaysia, the Philippines, Taiwan, and Thailand, Brooks and Persand (2001)
regress daily returns in each of these countries’ stock market on five dummy
variables D1 to D5 representing each day of the week – i.e., D1 for Mondays, D2
for Tuesdays, D3 for Wednesdays, D4 for Thursdays and D5 for Fridays:
rt = g 1D1t + g 2 D2t + g 3 D3t + g 4 D4t + g 5 D5t + ut
Their results were:
2. Which market(s) did not display any evidence of day-of-the-week effect?
(a) Thailand, Malaysia and Taiwan
(b) Philippines only
(c) South Korea only
(d)* South Korea and Philippines.

3. A Markov process can be written mathematically as:

(a) P [ a < yt < b | y1 , y2 ,... yt -1 ] = P [a < yt < b | yt -1 , yt -2 ]
(b) P [ a < yt < b | y1 , y2 ,... yt -1 ] = P [ a < yt < b | yt -2 ]
(c)* P [ a < yt < b | y1 , y2 ,... yt -1 ] = P [a < yt < b | yt -1 ]
(d) P [ a < yt < b | y1 , y2 ,... yt -1 ] ¹ P [ a < yt < b | yt -2 ] .

4. The unknown parameters of a Markov switching model are usually estimated

using:
(a)* Maximum likelihood
(b) Instrumental variables
(c) Indirect least squares
(d) Ordinary least squares.

5. The key difference between threshold autoregressive and Markov switching

models is that:
(a) The latter can be estimated using ordinary least squares while the latter is
estimated using the indirect least squares estimation technique
(b) Under the latter, the state variable is assumed to be known and observable,
while it is latent under the former
(c)* Under the former, the state variable is assumed to be known and observable,
while it is latent under the latter
(d) None of the above.

6. Which of these equations is a self-exciting threshold autoregressive (SETAR)

model?
(a)* yt = µ1 + f1 yt -1 + u1t if yt -k < r
yt = µ1 + f1 yt -1 + u1t if yt -k ³ r

(b) yt = µ1 + f1 yt -1 + u1t if st -k < r

yt = µ1 + f1 yt -1 + u1t if st -k ³ r

(c) yt = µ1 + f1 yt -1 + u1t if ft -k < r

yt = µ1 + f1 yt -1 + u1t if ft -k ³ r

(d) yt = µ1 + f1 yt -1 + u1t if ut -k < r

yt = µ1 + f1 yt -1 + u1t if ut - k ³ r .

7. To compare the goodness of fit of Markov switching and threshold

autoregressive models with linear models, one can compare the residual sums of
squares of the two types of models using an F-test. Is the statement true?
(a) Yes
(b)* No
(c) If the autoregressive model is restricted
(d) Cannot say without knowing the number of regimes in the regime switching
models.
8. Suppose that a researcher wishes to test for calendar (seasonal) effects using a
dummy variables approach. Which of the following regressions could be used to
examine this?
(i) A regression containing intercept dummies
(ii) A regression containing slope dummies
(iii) A regression containing intercept and slope dummies
(iv) A regression containing a dummy variable taking the value 1 for one
observation and zero for all others.

(a) (ii) and (iv) only

(b) (i) and (iii) only
(c) * (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).

9. If a series possesses the ‘Markov property’, what would this imply?

(i) The series is path-dependent
(ii) All that is required to produce forecasts for the series is the current value of
the series plus a transition probability matrix
(iii) The state-determining variable must be observable
(iv) The series can be classified as to whether it is in one regime or another
regime, but it can only be in one regime at any one time.

(a) * (ii) only

(b) (i) and (ii) only
(c) (i), (ii), and (iii) only
(d) (i), (ii), (iii), and (iv).

10. Consider the following two equations in a state space model, where yt is the
observed series, and ut and ηt are noise terms.

The two equations would respectively be termed as:

(a) * The measurement equation and the transition equation
(b) The data equation and the Markov equation
(c) The transition equation and the parameter model
(d) The measurement equation and the Markov process.

11. The ratio of the variance of the error term ηt to the variance of the error term ut
is used as the basis of a test for:
(a) * Whether it is necessary to allow for time-varying parameters
(b) Whether the observed series, yt, is excessively noisy
(c) Whether the Markov property holds
(d) Whether the Kalman filter will be efficient.
12. Consider the following two equations in a state space model, where yt is the
observed series, and ut and ηt are noise terms.

What would be the hyperparameters for this model?

(a) The transition matrix, Tt
(b) The state variable, μt
(c) The estimated values of the noise terms (i.e., the values of ut and ηt)
(d) * The variances of the noise terms (i.e., the variances of ut and ηt)’

Multiple Choice Test Bank Questions No Feedback – Chapters 11-14

Correct answers denoted by an asterisk.

1. Which of these are advantages of using panel data?

(I) We can address a broader range of issues and tackle more complex problems
than would be possible with pure time-series or pure cross-sectional data alone
(II) It allows us to increase the number of degrees of freedom
(III) It allows us to increase the power of the tests
(IV) We can remove the impact of certain forms of omitted variables bias in
regression results.

(a) I only
(b) I and II only
(c) I, II, and III only
(d)* I, II, III, and IV.

2. Which of these is a type of panel estimator approach?

(I) Fixed effects
(II) Random effects
(III) Seemingly unrelated regression effects
(IV) Time-varying effects.

(a) I only
(b)* I and II only
(c) I, II, and III only
(d) I, II, III, and IV.

3. Entity fixed effects models

(a)* Allow the intercept in the regression model to differ cross-sectionally but not
over time, while all of the slope estimates are fixed both cross-sectionally and over
time
(b) Allow the slope in the regression model to differ cross-sectionally but not over
time, while the intercept estimates are fixed both cross-sectionally and over time
(c) Allow the intercept in the regression model to differ over time, while all of the
slope estimates are different both cross-sectionally and over time
(d) Any of the above could be true depending on the model specification.

4. Running a cross-sectional regression on the time-averaged values of the

variables is known as a:
(a) Within estimator
(b)* Between estimator
(c) Cross-sectional estimator
(d) Demeaned estimator.

5. The acronym LSDV in panel model estimation stands for

(a) Least squares dependent variable
(b) Limited squares dependent variable
(c)* Least squares dummy variable
(d) Limiting squares dummy variable.

6. Which of the following is a mathematical expression of a time-fixed effects

model?
(a) yit = a + b xit + uit
(b) yit = a + b xit + µi + n it
(c) yit = a + b xit + wit , wit = e i + vit
(d)* yit = a + b xit + lt + n it .

7. What of the following is a mathematical expression of a random effects model?

(a) yit = a + b xit + uit
(b) yit = a + b xit + µi + n it
(c)* yit = a + b xit + wit , wit = e i + vit
(d) yit = a + b xit + lt + n it .

8. To test for unit roots in panel data, Levin, Lin and Chu (2002) develop a test
based on the equation Dyi ,t = ai + qt + dit + ri yi ,t -1 + å bi Dyi ,t -1 + vit . What is the
appropriate null hypothesis for this test?
(a) * H 0 : ri º r = 0
(b) H 0 : d i = 0
(c) H 0 : bi = 0
(d) . H 0 : q = 0

9. Logit and probit models are more appropriate than linear probability models
because:
(a) Logit and probit can estimate probabilities that are negative
(b) Logit and probit cannot estimate probabilities that are greater than one
(c) Logit and probit cannot estimate probabilities that are negative but not greater
than one
(d)* Logit and probit cannot estimate probabilities that are negative or greater than
one.

10. Which of the following statements about logit and probit models is true?
(I) They cannot be estimated by ordinary least squares
(II) They can be estimated using maximum likelihood
(III) They can be estimated using non-linear least squares
(IV) They can be estimated using instrumental variables.

(a) I only
(b) I and II only
(c)* I, II, and III only
(d) I, II, III, and IV.
11. If the maximised value of the log-likelihood function for a logit model is 34.55
and for a restricted model where all of the slope parameters are set to zero is
30.67, what is the pseudo-R2?
(a) 0.13
(b)* –0.13
(c) 0.11
(d) –0.11.

12. Appropriate modelling of limited dependent variables that are assigned

numerical values having a natural ordering can be done using:
(I) Probit models
(II) Logit models
(III) Ordered probit models
(IV) Ordered logit models.

(a) I only
(b) I and II only
(c) II and III only
(d)* III and IV only.

13. In the context of an event study, a cumulative abnormal return:

(a) Is calculated by summing the individual returns over all the firms separately
for each day
(b) * Is calculated by summing the individual returns over time for each firm
separately
(c) Takes the geometric product of the individual returns over all the firms
separately for each day
(d) Takes the geometric product of the individual returns over time for each firm
separately.

14. Which of the following statements is TRUE concerning the calendar time
methodology sometimes used in event studies?
(a) It will weight all the firms in the sample that underwent the event equally
(b) It can involve the calculation of a buy-and-hold abnormal return
(c) If the slope parameter in the test regression is positive and significant, this will
provide evidence of an abnormal return in the event study
(d) *It will give more weight in the sample to firms which underwent the event at
a time when few other firms did so.

15. The traditional Fama–MacBeth approach to tests of the CAPM involves:

(a) * A set of time-series regressions to estimate the betas for each stock and then
a cross-sectional regression to estimate the risk premium
(b) A set of cross-sectional regressions to estimate the betas and then a time-series
regression to estimate the risk premium
(c) A single cross-sectional regression to estimate the CAPM beta
(d) A time-series regression to estimate the betas for each stock and then another
time-series regression to estimate the risk premium.

16. In the Fama–MacBeth regressions, the parameter estimates in the second stage
are interpreted as:
(a) Factor loadings
(b) * Factor risk premia
(c) Average returns for each stock
(d) The volatilities of returns for each stock.

17. In the Fama–MacBeth regressions, the parameter estimates in the first stage
are interpreted as:
(a) * Factor loadings
(b) Factor risk premia
(c) Average returns for each stock
(d) The volatilities of returns for each stock.

18. In Fama–French (1993)- and Carhart (1994)-type models, for there to be no

evidence of outperformance by a fund manager, we would require:
(a) The intercept is positive but not statistically significant
(b) The intercept is not positive and significant and slope estimates are all
insignificant
(c) * The intercept is not positive and significant
(d) The slope estimates are all insignificant.

19. If we use the block maximum approach to estimating the parameters of a

member of the extreme value family of distributions and we select a large number
of short blocks, which of the following is a likely disadvantage?
(a) * A number of data points would be classified as extreme when they are not,
leading to bias in the shape parameter estimate
(b) Too few data points would be classified as extreme, leading to excessive noise
in the shape parameter estimate
(c) Too few data points would be classified as extreme, leading to bias in the shape
parameter estimate
(d) A number of data points would be classified as extreme when they are not,
leading to excessive noise in the shape parameter estimate.

20. Which of the following distributions would be most appropriate for modelling
the central part of the distribution of a set of stock returns?
(a) Gumbel
(b) Fréchet
(c) Weibull
(d) * Normal.

21. If we use the peaks-over-threshold approach to estimating the parameters of an

extreme value distribution, if we use a value of U, the threshold, that is too high
(i.e., too far into the tail), which of the following is a likely disadvantage?
(a) A number of data points would be classified as extreme when they are not,
leading to bias in the shape parameter estimate
(b) * Too few data points would be classified as extreme, leading to excessive
noise in the shape parameter estimate
(c) Too few data points would be classified as extreme, leading to bias in the shape
parameter estimate
(d) A number of data points would be classified as extreme when they are not,
leading to excessive noise in the shape parameter estimate.
 EXTRA
What are the steps for economic model building? - 1. Undertand finance theory
2. Derive estimable model
3. Collect data
4. Estimate model (with OLS)
5. Evaluate estimation results (Carry out diagnostic checks)
6. (Satisfactory - Interpret/Unsatisfactory - Reformulate)

Differences of financial vs economic data - Fin: higher frequency, better quality,

includes risk, noisy, non-normal suffering from kurtosis

Cross sectional data - Many observation at one point in time

Panel data - Many observations on many points in time

Explain the importance of the error term - The error term picks up all the effects
on y that are not explained by the constant or explanatory variable
Fitted value - Predicted value

T-Test in econometrics - (Fitted B)/(Stand Error of Fitted B)

Degrees of freedom at t-tests - N-k

Gauss-Markov assumptions - Conditions under which OLS is BLUE

What are te Gauss-Markov assumptions

(First 5 have to be true for the estimater to be BLUE) - 1. Linear in Parameters
2. Zero Conditional Mean E(Ut)=0
3. Homoskedasticity Var(Ut^2) = σ^2 < ∞
4. No Autocorrelation Cov(Ut, Us) = 0
5. Error Term and Explanatory Variable are uncorrelated Cov(Ut, xt) = 0
6. Normality of Errors Ut∼N(0, σ^2)
7. No perfect collinearity

OLS - Ordinary Least Square

BLUE - Best Linear Unbiased Estimator

What are the causes for the error term (Y-fittedY) - 1. Randomness
2. Omission of explanatory variables
3. Mis-specification of the model
4. Inorrect functional form of the model
5. Measurement error

How to do OLS -
Correlation coefficient (R) - A statistical index of the relationship between two
things (from -1 to +1)

What are the two ways to conduct a hypothesis test? - 1. Test of significance
2. Confidence interval approach
They give the same result

What to do with the critical value in the confidence intervall approach? - fittedB
- (critical value x SE(fittedB));
fittedB + (critical value x SE(fittedB))
If fitted B lies outside the values reject H0

Autocorrelation - It refers to the correlation among lagged values of a random

variable. Autocorrelation occurs in timeseries studies when the errors associated
with a given time period carry over into future time periods.

What causes autocorrelation? - 1. Inertia or persistence

2. Specification Bias- Excluded variable (eg quadratic relationship between Xt and
Ut)
3. Omitted Variables
4. Cobweb Phenomenon (Farmers plant on last years price)

Vt - Vt = (Ut) - (Ut-1)
What are the consequences of autocorrelation? - 1. OLS is still unbiased and
consistent
2. Hypothesis testing is no long valid
3. OLS will be inefficient and no longer BLUE
4. R^2 will be overestimated and T-statistics be lower

How can you detect autocorrelation? - 1. Graphical method

2. Durbin Watson test (1 leg)
3. Breusch-Godfrey test (multiple leg)

Parameters of Durbin Watson test - 1. 0 < DW < 4

2. DW has critical values (du - upper, dl - lower)
3. There is a region of indecisiveness
4. H0: ρ=0 no autocorrelation H1: ρ>0 1st order autocorrelation

Durbin Watson interpretation -

Parameters of Breusch-Godfrey Test - 1. Known as LM Test

2. Detects Nonstochastic regressors (legged)
3. Detects higher-order autogegressive schemes AR(2)
4. H0: ρ1=ρ2=ρr=0 no AC, H1: unequal 0 positive AC

Remedies for autocorrelation (ρ is known) - 1. Generalized least square GLS if

AC(ρ) is known (multiply t-1 with ρ and substract from original equation)

Remedies for autocorrelation (ρ is unknown) - 1. Obtain residuals

2. Estimate ρ from regressing the residuals to its lagged terms
3. Transform the original variables as starred variables
4. Run the regression again
5. Continue 2-4 until the estimates are close to 0.001

Cochrane-Orcutt - A procedure that can try to correct for auto correlation. (C-O)
Heteroscedasticity - A regression in which the variances in y for the values of x
are not equal

What are the causes of heteroscedasticity? - 1. Presence of outliers

2. Incorrect functional form of the regression
3. Incorrect transformation of data (mixing of scale)

Consequences of Heteroscedasticity - 1. OLS is still linear and unbiased

2. OLS has no longer the minimum variance
3. Incorrect standard errors for least squeres
4. R^2 is affected
5. Hypothesis and Confidence tests and standard errors are wrong

How can you detect heteroscedasticity? - 1. Goldfeld-Quandt (GQ)

2. White's general test

Steps in the White test - 1. Estimate the model, obtaining the residuals (fitted U)
2. Run the auxiliary regression
3. Obtain R^2 and multiply be the number of observations (T). TR∼x^2(m). m is
the number of regressors in the auxiliary regression excl. the constant term.
4. If x^2 statistic is greater than the corresponding from the table reject H0 that the
disturbances are homoscedastic.

Remedies for Heteroscedasticity - 1. Weighted Least Squares WLS, dived

regression by σ or another estimated term
2. Transforming the variables into logs

When do we use F-Tests? - In the presence of multiregression models

What are H0 and H1 in the F-Test? - H0 : β1 = β2 = βk = 0

H1 : not equal (if one is not =0 then reject H0)

F-Test formula - In formula k= # of estimated parameters included constant

R squared - Coefficient of determination - accuracy of prediction. How well the
independent variable predicts the dependent variable. Can range between 0 and 1.
If r squared = 0.8 then 80% of the variability in Y is "explained" by the variability
in X

adjusted R squared - This is the R value having taken into consideration the
amount of X variables. This is needed because the more X variables you add into
the model, the more it will explain however insignificantly so

What are other names for the dependent variable (y)? - 1. Regressand
2. The explained variable

What is the meaning of heteroscedasticity? - The variance of the errors is not

constant

What would be then consequences for the OLS estimator if heteroscedasticity is

present in a regression model but ignored? - It will be inefficient

Which of the following could be used as a test for autocorrelation up to third

order? - The Breusch-Godfrey test

If a Durbin Watson statistic takes a value close to zero, what will be the value of
the first order autocorrelation coefficient? - Close to plus 1

Suppose that a researcher wishes to test for autocorrelation using an approach

based on an auxiliary regression. Which one of the following auxiliary regressions
would be most appropriate? - ut = a0 + a1u(t-1) + v

If OLS is used in the presence of autocorrelation, which of the following will be

likely consequences? - 1. Hypothesis test coud reach the wrong conclusions
2. Standard errors may inappropriate
Which of the following are plausible approaches to dealing with residual
autocorrelation? - 1. Add lagged values of the variables to the regression
equation
2. Try a model in first differenced form rather than in levels

Including relevant lagged values of the dependent variable on the right hand side
of a regression equation could lead to which one of the following? - Biased but
consistent coefficient estimates

Near multicollinearity occurs when..? - Two or more explanatory variables are

highly correlated with one another

Which one of the following is a plausible remedy for near multicollinearity? - 1.

Use principal components analysis
2. Drop one of the collinear variables
3. Use a longer run of data

Which of the following are alternative names for the independent variable (usually
denoted by x) in linear regression analysis? - 1. Regressor
2. The causal variable

What will be the properties of the OLS estimator in the presence of

multicollinearity? - It will be consistent, unbiased and efficient

Suppose that the Durbin Watson test is applied to a regression containing two
explanatory variables plus a constant (e.g. equation 2 above) with 50 data points.
The test statistic takes a value of 1.53. What is the appropriate conclusion? - The
test result is inconclusive

Which of the following are plausible approaches to dealing with a model that
exhibits heteroscedasticity? - 1. Take logarithms of each of the variables
2. Use suitably modified standard errors
3. Use a generalised least squares procedure
Which are examples of mis-specification of functional forms? - 1. Using a linear
specification when y scales as a function of the squares of x
2. Using a linear specification when a double-logarithmic model would be more
appropriate
3. Modelling y as a function of x when in fact it scales as a function of 1/x

If the residuals from a regression estimated using a small sample of data are not
normally distributed, which one of the following consequences may arise? - Test
statistics concerning the parameters will not follow their assumed distributions

The residual (error term) from a standard regression model is defined as...? - The
difference between the actual value, y, and the fitted value, y-hat

Suppose that a test statistic has associated with it a p-value of 0.08. Which one of
the following statements is true? - 1. If the size of the test were exactly 8%, we
would be indifferent between rejecting and not rejecting the null hypothesis
2. The null would be rejected if a 10% size of test were used
3. The null would not be rejected if a 1% size of test were used

Suppose that observations are available on the monthly bond prices of 100
companies for 5 years. What type of data are these? - Panel

When there are omitted variables in the regression, which are determinants of the
dependent variable, then...? - The OLS estimator is biased if the omitted variable
is correlated with the included variable

Why is R2 not always a appropriate in a multivariate regression? - R2 rises

always when additional variables are added. In this case R2 adjusted is more
meaningful

What are the causes for an error term - 1. Randomness of nature

2. Omission of explanatory variables
3. Mis-specification of the model
4. Incorrect functional form of the model
5. Measurement error
MULTIPLE CHOICES MID-TERM
1. Which of the following null hypotheses could we test using an F-test? (i) b2 = 0,
(ii) b2 = 1 and b3 + b4 = 1, (iii) b3xb4 = 1, (iv) b2 + b3 + b4 = 1

a. (ii) and (iv) only

b. (i) and (ii) only

c. (i), (ii), and (iv) only

d. (i), (ii), (iii) and (iv)

2. Which of these is not a viable ‘solution’ for heteroscedasticity?

a. Using heteroscedasticity-consistent standard error estimates

b. Transforming the variables into logs

c. Taking the first differences of the series

d. Using generalised least squares ifr the form of heteroscedasticity is known

3. Which of the following is a correct interpretation of a “95% confidence interval”

for a regression parameter?

a. In repeated samples, we would derive the same estimate for the coefficient 95% of
the time

b. We are 95% sure that the interval contains the true value of the parameter

c. We are 95% sure that the interval contains our estimate of the coefficient

d. We are 95% sure that our estimate of the coefficient is correct

4. The method of estimating econometric models which involves fitting a line to

the data by minimising the sum of squared residuals is the

a. Method of ordinary least squares

b. Method of maximum likelihood

c. Method of moments

d. Method of generalised squared moments

5. What would be the consequences for the OLS estimator if autocorrelation is

present in a regression model but ignored?

a. It will be biased

b. It will be inefficient

c. All of A., B. and C. will be true.

d. It will be inconsistent

6. Which of the following would NOT be a potential remedy for the problem of
multicollinearity between regressors?

a. Transforming two of the explanatory variables into ratios

b. Collecting higher frequency data on all of the variables

c. Transforming the data into logarithms

d. Removing one of the explanatory variables

7. Which estimation results of the two methods will give the same regression
results of slope coefficients?

a. LSDV and between estimator

b. first differences estimator within transformation

c. LSDV and first differences estimator

d. LSDV and within transformation

8. Appropriate modelling of limited dependent variables that are assigned

numerical values having a natural ordering can be done using: (I) Probit models,
(II) Logit models, (III) Ordered probit models, (IV) Ordered logit models
a.III and IV only

b.I and II only

c.II and III only

d.I only

9. To test the validity of instruments in the 2SLS model, which test can be used?

a.Wu-Hausman test

b.Durbin-Watson test

c.Sanderson-Windmeijer test

d.Sargan/Hansen J test (test of overidentifying)

10. If a regression equation contains an irrelevant variable, the parameter

estimates will be

a.Consistent and asymptotically efficient but biased

b.Consistent and unbiased but inefficient

c.Consistent, unbiased and efficient

d.Inconsistent

11. Which one of the following is the most appropriate as a definition of R2 in the
context that the term is usually used?

a.It is the proportion of the total variability of y that is explained by the model

b.It is the correlation between the fitted values and the residuals

c.It is the correlation between the fitted values and the mean

d.It is the proportion of the total variability of y about its mean value that is
explained by the model
12. If the residuals of a regression on a large sample are found to be
heteroscedastic which of the following might be a likely consequence? (i) The
coefficient estimates are biased, (ii) The standard error estimates for the slope
coefficients may be too small, (iii) Statistical inferences may be wrong

a. (i), (ii) and (iii)

b.(i) only

c.(i) and (ii) only

d.(ii) and (iii) only

13. A researcher wants to evaluate the effect of a variable z (binary variable) on

the relationship between the independent variable x and the dependent variable y.
Which model should the researcher use ?

a.y_t=α + βx_t + γz_t + δz_t x_t + u_t

b.y_t=α + βx_t + γz_t + u_t

c.y_t=α + βx_t + γz_t + δz_t^2 + u_t

d.y_t=α + βx_t + γz_t + δy_(t-1) x_t + u_t

14. Which one of the following is NOT an assumption of the classical linear
regression model?

a.The disturbance terms have zero mean

b.The explanatory variables are uncorrelated with the error terms.

c.The disturbance terms are independent of one another.

d.The dependent variable is not correlated with the disturbance terms

15. Which of the following statements are true about parameter stability tests? (I)
Parameter stability tests test the assumption that the estimated parameters of a
model are constant for the entire sample, (II) Chow test and predictive failure tests
are two types of parameter stability tests, (III) Backward and forward predictive
failure tests are two types of parameter stability tests, (IV) Parameter stability
tests examine violations of the classical linear regression model assumptions

a. I, II, III and IV

b. I and II only

c. I only

d. I, II and III only

16. Which of these is not a reason for adding a disturbance term to a regression
model?

a. Some determinants of the effect variable may be omitted from the model

b.Some determinants of the effect variable may be unobservable

c.There may be errors in the way that the dependent variable is measured which cannot
be modelled

d.Some determinants of the independent variable may be omitted from the model

17. The value of the Durbin Watson test statistic in a regression with 4 regressors
(including the constant term) estimated on 100 observations is 3.6. What might we
suggest from this?

a.The residuals are negatively autocorrelated

b.The residuals are positively autocorrelated

c.There is no autocorrelation in the residuals

d.The test statistic has fallen in the intermediate region

18. Suppose you have calculated the following regression results: y = 1.25 + 0.64x.
The standard errors of alpha and beta are 1.22 and 0.58, respectively. Using the
test of significance approach, what is the test statistic value of a hypothesis to
test whether the true value of beta statistically different from zero?

a.0.91
b.1.10

c.Cannot say without more information

d.-0.62

19. Which of the following conditions must be fulfilled for the Durbin Watson test
to be valid? (i) The regression includes a constant term, (ii) The regressors are
non-stochastic, (iii) There are no lags of the dependent variable in the regression,
(iv) There are no lags of the independent variables in the regression

a.(i), (ii), (iii) and (iv)

b.(i), (ii) and (iii) only

c.(i) and (ii) only

d.(i), (ii), and (iv) only

20. Entity fixed effects models

a. Allow the intercept in the regression model to differ cross-sectionally but not over time,
while all of the slope estimates are fixed both cross-sectionally and over time

b.Any of the above could be true depending on the model specification

c.Allow the slope in the regression model to differ cross-sectionally but not over time,
while the intercept estimates are fixed both cross-sectionally and over time

d.Allow the intercept in the regression model to differ over time, while all of the slope
estimates are different both cross-sectionally and over time

21. Standard errors

a. Give us an idea of the precision of estimates of alpha and beta

b. Measure the reliability of the independent variables

c. Measure the reliability of the dependent variables

d. Give us an idea of the deviation of the errors from their mean

22. Which of these is not a consequence of ignoring autocorrelation if it is

present?

a. The coefficient estimates derived using OLS are not the best linear unbiased
estimators

b. The coefficient estimates derived using OLS are biased

c. Standard error estimates are inappropriate

d. The coefficient estimates derived using OLS are inefficient

23. Which of the following would probably NOT be a potential “cure” for non-
normal residuals?

a.Transforming two explanatory variables into a ratio

b.Removing large positive residuals

c.Using a procedure for estimation and inference which did not assume normality

d.Removing large negative residuals

24. Which of the following statements is correct concerning the conditions

required for OLS to be a usable estimation technique?

a.The model must be linear in the residuals

b.The model must be linear in the variables
c.The model must be linear in the parameters
d.The model must be linear in the variables and the parameters

25. Which of these is a characteristic of financial data?

a.It is easy to separate underlying trends from random and uninteresting features

b.They are considered to be very noisy

c.The number of observations is usually very small

d.They are observed at much lower frequencies than macroeconomic data

26. Which of the following null hypotheses could we test using an F-test? (i) b2 =
0, (ii) b2 = 1 and b3 + b4 = 1, (iii) b3xb4 = 1, (iv) b2 + b3 + b4 = 1

a.(ii) and (iv) only

b.(i) and (ii) only

c.(i), (ii), (iii) and (iv)

d.(i), (ii), and (iv) only

27. To deal with endogeneity, which regression model can be applied?

a. Cochrane-Orcutt procedure

b. logistic regression

c. general least squares regression GLS

d. instrumental variable regression

28. Consider a bivariate regression model with coefficient standard errors

calculated using the usual formulae. Which of the following statements is/are
correct regarding the standard error estimator for the slope coefficient? (i) It
varies positively with the square root of the residual variance (s), (ii) It varies
positively with the spread of X about its mean value, (iii) It varies positively with
the spread of X about zero, (iv) It varies positively with the sample size T

a. (i), (ii), (iii) and (iv)

b. (i) and (iv) only

c. (i), (ii) and (iv) only

d. (i) only

29. To select between fixed effect and random effects models, which test should
be used?
a.F test for all regression coefficients of the entities’ dummy variable equal to 0

b.Wald test

c.Breusch-Pagan test

d.Hausman test

What is the most appropriate interpretation of the assumption cov(ui,uj)=0

concerning the regression disturbance terms?

a.

The errors are linearly dependent of one another

b.

The errors are nonlinearly independent of one another

c.

The errors are linearly independent of one another

d.

The covariance of the errors is constant and finite over all its values

Which of these is a test for heteroscedasticity?

a.White test

b.Bera-Jarque test

c.Breusch-Godfrey test

d.Breusch-Jagan test