Answer Happy

Question 1
The Lusaka stock exchange has been facing a volatility in stock
prices of various companies that have been listed on the stock
exchange. This is largely because of the prevailing macroeconomic
indicators in Zambia. This is a result of factors like the
depreciation of the Kwacha compared to other foreign currencies,
high inflation, high interest rates and the impact of the Covid 19
epidemic. Given that the stock price model for data from 2010 to
2020 on the stock exchange for Zanaco shares is as follows;
𝜌𝑡−1 = 𝛽𝜌𝑡−2 − 𝛽1𝜌𝑡−3 + 𝛽2𝜌𝑡−4 + 𝜀
Where 𝜀 = 𝑠𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒𝑠
a) Explain the key assumptions under the classical regression
models that would qualify
this stock price model to be reliable in giving consistent
parameter estimates. (10 marks)
b) In the event that there is a relationship between 𝜌𝑡−1 𝑎𝑛𝑑
𝑡ℎ𝑒 𝑒𝑟𝑟𝑜𝑟 𝑡𝑒𝑟𝑚 𝜀. Which of
the assumptions is violated and what problem arises in the
model. (10 marks)
c) Derive the O.L.S estimator 𝛽 for the relationship between
stock prices and interest
rate given that you are having a multivariate model where
interest rate is one of the
variables using the O.L.S matrix notation:
𝑌 = 𝑋𝛽 + 𝜀 (10 marks)
d) Explain why the strict exogeneity assumption is important for
the model and the
significance of the 𝜀 in the model (10 marks)