Answer Happy

QUESTION FOUR I present below the following population regression functions: VAL= Bo + B₁ DTB + ut, (Equation 1) o Ao + A₁u₁ + A₂u²-2, = (Equation 2) where VAL denotes equity valuation, represented by the price- earnings ratio (total equity price at the end of year divided by earnings in that year), DTB = dividend tax burden (the proportion of dividend yield paid out as tax, in annual percentage; dividend yield = ratio of the total dividend amount to the total market value of constituent stocks). The time subscript denotes the year, and u, is a random disturbance term in year t, normally distributed with 0 mean and unknown variance of. Please answer the following questions. Justify your answers and show all workings. (a) Identify the process that Equations 1 and 2 represent. Interpret both equations. [10 marks] (b) Suppose that in Equation 2 above A₁ + A₂ = 1. Provide both economic and statistical implications of such an assumption. [15 marks] (c) What are the restrictions that the process identified 1 and 2 above must satisfy? Justify your answer. in Equations [15 marks] (d) Explain how you would calculate a 20-step ahead forecast of the variance of the price-earnings ratio. Provide a numerical example of the 20-step ahead variance forecast. [20 marks]
(e) A financial theory predicts that investors should be rewarded for taking additional risk by attaining a higher price-earnings ratio. Explain how Equations 1 and/or 2 can be extended to test this prediction. [20 marks] (f) to account Explain how Equations 1 and/or 2 can be extended for the leverage effect in the stock market. [20 marks]