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Analyzing the Effect of a Market Jump on an Equity’s Returns

Analyzing the Effect of a Market Jump on an Equity’s Returns. Junior Research Seminar Economics 201FS. Outline. Motivation Capital Asset Pricing Model Objective Summation of Results UPS GE Interpretation Future Work. Motivation.

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Analyzing the Effect of a Market Jump on an Equity’s Returns

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  1. Analyzing the Effect of a Market Jump on an Equity’s Returns Junior Research Seminar Economics 201FS

  2. Outline • Motivation • Capital Asset Pricing Model • Objective • Summation of Results • UPS • GE • Interpretation • Future Work

  3. Motivation • Look at the role of the market’s jumps in the financial markets • How do they effect returns of individual equities? • How fine can our sampling intervals be? • Potential consequences for hedging strategy

  4. Capital Asset Pricing Model Expected Return of Equity = Risk-free rate + (Beta * Market Premium) Beta = Cov(Market Return, Equity Return) / Var(Market Return) Assumptions: • Market return and residual are uncorrelated • Residuals are mutually uncorrelated • Residuals are difference between actual return and predicted return

  5. Average Beta: 0.4372

  6. Average Beta Over Time Interval: 0.4017 Beta (Yahoo Finance): 1.37

  7. Average Beta over Time Interval: 0.5830 Beta (Yahoo Finance): 0.41

  8. Objective • Introduce a dummy variable (Jmt), that depends on if the market (SPY) jumped • Lee/Mykland • rcmt = (1-Jmt)(rmt) • rjmt = (Jmt)(rmt) rit = αi + βic (1-Jmt)(rmt) + βij (Jmt)(rmt) + εit

  9. UPS Results 65,536 observations (about 68.5% of data)

  10. UPS Results

  11. UPS Results

  12. GE Results

  13. GE Results

  14. GE Results

  15. Interpretation • Market jump return component does not help predict the equity’s return at the 95% significance level when using five-minute returns

  16. Further Work • Implement formally the Scholes and Williams method (1977) • Extend work to other 40 stocks • Work with different sampling intervals

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