Submission instructions:
1. Maximum word length: 2000 words.
2. Submit a soft copy in word format via Turnitin (with an assignment cover sheet). You can also submit an Excel spreadsheet that shows your workings. The Excel file, however, will not be marked. It is only submitted so that your working out can be checked as required. The word file will be marked, therefore, should be a stand-alone report. You should copy the key results from the Excel file and present them in table format in the word document.
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You are a research analyst and responsible to write a research report on the risk exposure of Australian financial institutions. More specifically, you will examine sensitivity of the stock returns of four Australian commercial banks, two major and two regional (Commonwealth Bank, National Australia Bank, Bank of Queensland, and Bedigo and Adelaide Bank), two insurance companies (Suncorp Insurance and QBE insurance), and three other financial services providers (Macquarie Group, EQT Holdings Ltd, and Euroz Limited) to the change in multiple risk factors associated with the operations of financial institutions.
You are required to estimate a multifactor model of stock returns that incorporates market returns, interest rate, and exchange rate changes in line with Choi, Elyasiani and Kopecky (1992). These factors respectively capture market risk, interest rate risk and exchange rate risk. Estimate the following regression model of financial institution stock returns, where is stock return of the ith financial institution in time is the return of S&P 500 Index, is return on the S&P/ASX All Ordinaries Index; represents change in 10-year Commonwealth government bond yield; represents change in the AUD/USD spot exchange rates; and is the random error term at month. You can watch the video on how to estimate a regression model on blackboard
Effect of the global financial crisis:
The global financial crisis in 2007-2008 may have caused a change in the Australian financial institutions’ exposure to different types of risk. To explore this conjecture, estimate the above model (equation 1) for two different subsamples, pre-crisis and post-crisis periods
Effect of the Introduction of Deposit Insurance:
With the advent of the global financial crisis, Australia introduced Deposit and Wholesale Funding Guarantee (DWFG) scheme. This scheme guaranteed funding in case of a bank's insolvency, which ultimately reduced a bank runs probability. This also may have reduced financial institutions’ risk exposure. Once again, to explore this issue, estimate equation 1 for two different subsamples, before the introduction of DWFG and after the introduction of DWFG. You need to find out the date of the introduction of deposit insurance for this exercise.
Effect of the Covid-19 crisis:
In addition to the risk factors included in equation 1, also consider a dummy variable to examine the effect of the COVID-19. Estimate the following model:
where is a dummy variable reflecting the effect of COVID-19 crisis. This variable should take a value of one if a particular month corresponds to the COVID-19 crisis period, and zero otherwise. You may consider 1 January 2020 to 30 June 2020 as the COVID-19 induced crisis period. You can watch the video on how to create a dummy variable and estimate a regression model on blackboard
Data Sources
Monthly stock prices for the chosen financial institutions, the S&P500 Index, ASX All Ordinaries Index, and monthly exchange rates are available in FACTSET.1 Yield on Commonwealth government 10-year bond can be obtained from Reserve Bank of Australia (RBA) website. Note that you may have to merge two datasets from RBA: July 1969- May 2013 and July 2013 to current. RBA report these data in two separate spreadsheets. You can watch the video on how to download data from FactSet and RBA on blackboard
Estimation Period
You should estimate the model for a sample period of January 2001 – December 2020. If the data for a given financial institution are not available for the estimation period, you need to estimate only for available periods.
Referencing Style
American Psychological Association (APA) 6th Edition. You can find helpful examples of APA 6th ed. citation here.
Required
Write a research report based on the empirical duration model as given in Equation (1) and Equation (2) with the following parts:
a. Introduction
You should theoretically discuss why financial institutions are sensitive to different risk factors such as overall market movement, changes in interest rates, and exchange rates. This section should also highlight the empirical literature on this topic)
b. Data and Methodology
You should discuss the model, sample size, sample period, and sources of data etc. Clearly explain how you explore the effect of different risk factors on the financial institutions stock returns. Also mention how you examine the effect of global financial crisis, introduction of deposit insurance scheme and the COVID-19 crisis on the
c. Findings
You should present and discuss the results from equation 1 first. Do you find any difference in results for three groups: major banks, insurance companies, and other financial services providers? If yes, how would you justify this difference. Relate your findings with relevant theories and previous empirical results.
