# MAE356 – Analytical Methods in Economics and Finance

MAE356 – Analytical Methods in Economics and Finance
MAE356 T2 2015 – Assignment Instructions   1
ANALYTICAL METHODS IN ECONOMICS AND FINANCE
TRIMESTER 2 – 2015
DUE DATE: WEDS 23RD SEPTEMBER 11:59PM.
 This assignment has 3 Parts each with a number of questions. Each part needs to be completed in order to obtain the full marks. The whole assignment is out of questions total 90 marks and will be converted to 20% of your final grade.    An electronic copy of the assignment has to be uploaded to Cloud Deakin by 11:59pm 23rd  September 2015. Please do not leave this to the last minute as technical problems will not be accepted as a reason to not submit on time.
 Late assignments without prior approval will be penalized at 10% per day late and if late by more than 3 days will not be marked.
 Academic staff can help to clarify aspects of the assignment questions(s) but please do not ask us regarding aspects of assignment answers as these will be ignored.
 Feel free to discuss the assignment amongst yourselves but please do not post up your answers on the discussion boards!
 Ultimately, this is your own assignment and while we encourage “collaboration” between students in terms of discussion to help each other out, plagiarism and collusion is directly prohibited as per your student code of conduct and will be penalized accordingly.

MAE356 – Analytical Methods in Economics and Finance
MAE356 T2 2015 – Assignment Instructions   2
ASSIGNMENT 1: MODELLING ESTABLISHED HOUSE (RESALE) PRICES FOR MELBOURNE
Housing affordability is a major issue in Australia these days. House prices in Melbourne has
soared in the last 5 years. In this assignment you are asked to model established house
(resale) prices in Melbourne.
To that end, you are presented with the housing.xsls data set. Your data set contains your
dependent (or explained or Y) variable, Quarterly Established Median House Prices in
Melbourne, from March 2002 to March 2014 (49 observations).
It also contains 6 other potential independent (or explanatory or X) variables.  Namely
(quarterly): Australian Real GDP (Percentage Change) (GDP); Exchange Rate (AUD/USD) (FX);
Inflation in Melbourne (CPI) (INF); Interest Rate (Cash Rate) (INT); Percentage Australian
Population Change (POP); Real (National) Weekly Wages (in 100’s Dollars) (WAGE). Listed
here in alphabetical order.
house prices. In order to model house prices (which you may call HP) answer the questions

MAE356 – Analytical Methods in Economics and Finance
MAE356 T2 2015 – Assignment Instructions   3
PART A: UNDERSTANDING THE DATA
1. For your dependent variable (housing prices), compute the following and provide a brief interpretation of: a. Mean b. Median c. Standard Deviation d. Skewness e. Kurtosis  (5 x 2 marks = 10 marks)
2. If we assume that house prices were actually normally distributed and assuming the mean and standard deviation you calculated in (1) is a good approximation of the population mean and population standard deviation;
a. What would the probability be that a given house selected at random would have a house price above \$700,000?
b. What would the probability be that a group of 20 houses would have an average house price less than \$500,000? (Hint: think about this one a little bit, it’s more obvious than you think)
(2 x 5 marks = 10 marks)
3. You believe house prices may have some outliers. In the presence of outliers, would the mean or median be the better measures of central tendencies? Briefly justify your answer.
(5 Marks)
(TOTAL FOR PART A: 25 MARKS)

MAE356 – Analytical Methods in Economics and Finance
MAE356 T2 2015 – Assignment Instructions   4
PART B: SIMPLE LINEAR REGRESSION ANALYSIS
In this section you will be invited to build a simple linear regression model.
1. Under ideal conditions, Ordinary Least Squares (OLS) is said to be a preferred choice of estimation/method as it is the best linear unbiased estimator (BLUE). What are these ideal conditions? List them in their mathematical notation form and briefly, in one or two lines, describe what they mean. (10 marks)
2. For the following simple regression models, briefly discuss your a priori expectations regarding the slope coefficient. Justify your answer using either economic theory, intuition, or examples via case studies.
i.
ii.
iii.
iv.
Note – In terms of the  a priori expectations you should be stating what you expect the relationship between the dependent and explanatory variable to be like; i.e. positive, negative, or no relation. (4 x 2 marks = 8 marks)
3. For each of the simple regression models as per Part B – Qn (2) estimate each model separately using the Least Squares method and present your results in as an estimated simple regression function rather than in its tabular form.
(4 x 1 mark = 4 marks)
4. Based on the above answer from Part B, interpret your estimated intercept and slope coefficients. During your interpretation, indicate whether the results meet you’re a priori expectations. If not then discuss why you think it may differ.
(4 x 2 marks = 8 marks)
MAE356 – Analytical Methods in Economics and Finance
MAE356 T2 2015 – Assignment Instructions   5
PART B: SIMPLE LINEAR REGRESSION ANALYSIS (CONTINUED)
5. Based on the above models, carry out the following tests using a 1% and 5% level of significance.
a. Test whether Percentage Australian Population Change has a statistically positive and significant effect on house prices.
b. Test whether Interest Rate (Cash Rate) has a statistically negative and significant effect on house prices.
Note – As part of your hypothesis test you will need to indicate the Null and Alternative hypotheses, the test statistic itself along with how you would manually calculate it, the critical value, and your conclusion which relates back to the example.
(2 x 5 marks = 10 marks)
(TOTAL FOR PART B: 40 MARKS)

MAE356 – Analytical Methods in Economics and Finance
MAE356 T2 2015 – Assignment Instructions   6
PART C: MULTIVARIATE REGRESSION ANALYSIS
In this section you will be building on the simple regression analysis and doing a multivariate regression model.
1. Noting that your dependent variable is Median House Price, and your independent variables are: Australian Real GDP; Exchange Rate (AUD/USD); Inflation in Melbourne (CPI); interest rates (Cash Rate); Percentage Australian Population Change (Pop); and Real National Weekly Wages:
a. Add all the independent variables as per above to your model and specify the population regression function in its proper notational form.
b. Estimate the model and interpret the estimated coefficients (intercept/slope). It is sufficient to just show the regression output table.
(1 + 8 = 9 marks)
2. After having done the estimation, we would like to verify the validity of our model and whether it sufficiently explains Median House Prices in Melbourne. To that end:
a. Test that the model is overall significant at the 5% level of significance. In your answer, state the null and alternative hypotheses, the test statistic and it’s calculation, the critical value, and your conclusion.
b. What is the explanatory power of your model and how is it measured?
c. Compare your models from Part (B) to Part (C), which of these models would you prefer and why?
(5 + 4 + 2 = 11 marks)
3. Adding extra independent variables on the surface might help improve our models fit, by pure reasoning then, we should keep adding more and more variables into the model. Why might this be a bad thing?
(5 Marks)
(TOTAL FOR PART C: 25 MARKS)
END OF ASSIGNMENT