EC3214 Financial Economics II Spring 2023 Coursework Assignment

Assignment Task

The Excel file has UK quarterly data on average bond yields (in %), GNP, Total Domestic Consumption Expenditure, Consumption of Durables (all at current prices), and the RPI, over the period 1996 Quarter 1 through to 2022 Quarter 3. The data has been converted for your use, to save you time.

Refer to the study by Estrella and Hardouvelis (1991), in particular, the models presented in Tables I and II. We want to replicate the model with more recent data and for the UK economy.

Use Excel for this coursework, as we are aiming at being proficient in it. Use the Data Analysis tool under DATA. If it is not there, you need to add it in from Options (under File). We will be using the Regression command for the coursework. Examine your data, and plot some relevant charts. The data from the year 2020 onwards are unusual in GDP and Consumption, because of the pandemic. You may, if you wish, leave this period out of your analysis.

Produce a nice write-up, with your own reconstructed tables that show the regression results similar to the ones in the original paper (though you may drop reporting the SSE). Do not copy and paste the output tables from Excel – they look messy

Explain the model that Estrella and Hardouvelis are testing: what does the term structure of interest rates tell us?

Investigate cumulative quarterly changes in GNP using the regression model

k is the forecasting horizon in quarters

Y_t+k is the level of real GNP in quarter k,

Y_t,t+k denotes the percentage change from quarter t to future quarter t + k

You need to figure out how to calculate SPREAD from the paper and convert the nominal measures to real measures.

As an illustration, the model says, for the forecasting horizon k = 3, how the spread in Quarter 1 of 2007 predicts the cumulative quarterly change in GNP in Quarter 4 of 2007.

Further, also examines marginal changes. For example, is it possible to predict how the economy will do from one quarter to the other, one year from now? For that, you need to find the marginal quarterly change in GDP from future quarter t+k-j to quarter t+k, a year from now.

Ie in Quarter 1 of 2007, can the spread predict quarterly GNP change from Quarter 4 of 2007 to Quarter 1 of 2008? (here, k = 4 and j =1) Further, look at the model for k = 6 and j = 4. For the Total Consumption and the Consumption of Durables data,

For k = 1, 4, 6, and 8

k is the forecasting horizon in quarters

C_t+k the level of consumption in quarter k,

C_t,t+k denotes the percentage change from quarter t to future quarter t + k

Do not do the marginal analysis for consumption.

Summarize your findings. What can you conclude? How do your results compare with the existing theory on the predictive power of the yield curve?

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