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Group Project Assignment
This project asks students to estimate and test standard asset pricing models as
discussed in the course, and to provide a qualitative evaluation of the results of this
exercise in the context of the relevant theoretical framework. The objective is to
allow students to demonstrate their conceptual understanding of the theory, as
well as their ability to apply this knowledge to a concrete empirical investigation.
The main focus is on time-series and cross-sectional tests of arbitrage pricing theory
within a cryptocurrency context. Although the key research questions are the same
for all groups, each group is given a different data set and will hence obtain
different results. Your mark for this project will be based primarily on the
competence with which the empirical analysis is implemented and, most
importantly, the quality of the discussion. Note that the empirical exercise that is
outlined below has (as of yet) not been fully researched within a cryptocurrency
asset pricing context. As such, we re-emphasize that the motivation and discussion
component of your final hand-in is of utmost importance.
READ THIS ? FIRST!
Why oh Why? … you may ask. Why are we practising implementing empirical tests of models?
Surely other people have done this before and we could just base our decisions on
their findings? A short answer is given by the motto of the Royal Society1
: “Nullius
in Verba” (loosely translated as “take no-one’s word for it”). In a situation where
(in your future career, for instance) your bonus, your reputation, or even your job is
on the line, would you really want to trust someone else’s judgement to choose the
model, methodology, or theory that you base your company’s (or indeed your own,
personal) million-dollar business decisions on?
If you are content to be the kind of person who simply does, without
questioning, what others tell you when making life or business decisions, then
you’re in the wrong place (you should not be doing a Masters degree!) By
pursuing a higher degree at “Master of Science” level, you are clearly stating
(“revealed preferences”, economists would say) your intent to be the kind of
person who makes their own, independent choices. Be a “decision-maker” rather
than a “decision-taker”!
So … We need to learn how to assess, objectively and independently, the tools at our
disposal for validity and suitability so that we can, with confidence, choose the
“right one” to apply to the problem we wish to solve. More importantly, we must
learn how to identify the shortcomings of existing tools or methods, so that we
know how to tweak existing ones, or even build our own from scratch, to be sure
we’re using the “best possible tool for the job at hand.”
This is what the project is all about.
The file contains monthly log return data
The “Crypto Returns” sheet contains daily log returns on 61 cryptocurrencies
downloaded2
The reported figures are
“raw” daily log returns (not annualised). For example, the entry “7.4%” for ANT for
the day of the 5th October 2017 means that the price of Aragon at the end of the
5
A day
is defined as a 24-hour period with a sampling time of 00:00:00 GMT. In other
words, relative to the USD which is used as the quote currency, Aragon (ANT) has
increased in value. A lengthy filtering process is undertaken to filter out illiquid
cryptocurrency pairs and pairs which exhibit very low trading volume. The initial
sample included over 3000 pairs which were sequentially screened using raw
exchange volumes, the Amihud liquidity ratio and the Abdi-Ranaldo low-frequency
bid-ask spread measure.
? Sheet “Cryptocurrency Factors”:
This sheet contains daily data (covering the same sample period from October 2017
to 7th November 2019) for five “cryptocurrency” based factors which are derived
from common risk factors identified in generic currency (FX) and equity markets:
DOL - Equal-Weighted: Introduced by Lustig et al. (2011) as a “dollar risk factor”
in currency markets. Constructed as the average return to holding the entire
basket of cryptocurrencies in the sample at each time t. In other words, this
“risk factor” is simply the equally-weighted market return across all
cryptocurrencies quoted in USD for each time t. This factor could be
considered analogous to the “market risk factor” in stock markets except
that the returns are equal weighted as opposed to market-cap weighted.
DOL - Volume-Weighted: As opposed to using equal-weights, trading volume (in
USD) is used to weight the return of each cryptocurrency.
REV: The “Short-Term Reversal” risk factor is a long-short portfolio which initiates
a long position in cryptocurrencies which had poor returns in the previous
day and a short position in stocks that had higher returns. This risk factor is
most similar to a short-term reversal portfolio first identified in equity
markets by Jegadeesh (1990). This factor is not given to you; constructing it
forms part of the empirical exercise.