ECN220 Project – Updated 22/02/2022

The submission deadline for all components of the Applied Portfolio is Monday 23 May by 12.00 noon. All submissions must be uploaded to the L2 Applied Portfolio Blackboard organisation

The module does not have dedicated workshops or lectures for the project, but there will be signposts throughout the semester to support the task. The project should demonstrate applications of concepts and techniques learned in the class; you should also be able to provide a good interpretation of the results that you produce.

The behaviour of interest rates during recessions.

 The aim of the project is to study the behaviour of various interest rates across recessions and financial crises. You will organize, graph and interpret the data. You will also use various econometric tools to understand the behaviour of interest rates during recessionary periods.

 

Section 1 (Data cleaning and basic analysis)

Log on to the Federal Reserve Economic Data website (FRED) (you may have to register)

 

https://research.stlouisfed.org/fred2/categories

Go to the sub-field “Interest Rates”.

Download the following interest rates (feel free to download more interest rates of your choice).

When possible use monthly frequency from the starting observation of the series to the last observation of 2019:

  1. Moody’s Seasoned Aaa Corporate Bond Yield (AAA)
  2. Moody’s Seasoned Baa Corporate Bond Yield (BAA)
  3. 30-Year Conventional Mortgage Rate (MORTGAGE)[1]
  4. Bank Prime Loan Rate (PRIME)
  5. 3-Month Treasury Bill: Secondary Market Rate (TBILL3)
  6. Effective Federal Funds Rate (FFR)

 

  1. Load all the data in a single Excel file (or Stata file) and graph the series. Make sure that the x- and y- axes are correctly labelled. Provide a table with some basic descriptive statistics: Min, Max, St. Dev., Mean. Show the matrix of correlation coefficients.. Report this.
  2. Looking at the graph in #1 provide a brief (about 250 words) comment on the dynamics of the various interest rates. (Hint: use the economic theories studied in the module)
  3. Standard intermediate macro models, such as IS-LM, postulate the presence of a single interest rate. Does that hypothesis hold in the data? Why or why not? (Max 1000 words).

 

Section 2 (Empirical section)

This section looks at the behaviour of alternative interest rates across past recessions.

 

  1. Use the data collected in section 1 to generate the following interest rate spread:

 

  1. SPt= BAA-AAA

 

  1. Generate a recession dummy variable (i.e. a variable that takes the value of 1 during recession periods and 0 otherwise). Data from the recessions can be downloaded here http://www.nber.org/cycles/cyclesmain.html (Recessions go from peak, the first date, to trough, the second date).
    1. Estimate the following regression for the period 1919M1-2019M12:

 

Where  is the spread (BAA-AAA) that you have created before,  is the dummy capturing the recessions and  is the error term.

 

Report coefficient estimates, standard errors, and R2. Present your results in a table and, using the theory studied throughout the semester, comment on your estimated coefficient. (Max 250 words, table(s) excluded).

 

  1. Generate three new variables to capture the financial crises:
    1. A dummy variable, , which takes the value of 1 during the 1929 crisis, 0 otherwise (approximate the dates using the 1929-33 recession dates used above).
    2. A dummy variable, which takes the value of 1 during the 2007 crisis, 0 otherwise (approximate the dates using the 2007-09 recession dates used above)
    3. A dummy variable, , which takes the value of 1 during recessions (but excluding the 1929-33 and the 2007-09 episodes), 0 otherwise.
    4. Estimate the following regression:

 

 

Where  is the spread (BAA-AAA) that you have created before, ,  and  are the dummy variables described above.  is the error term. Please report coefficient estimates, standard errors, and R2.

  1. Comment on the results obtained (about 500 words).
    1. What is the economic significance?
    2. Are the results econometrically sound?
  2. From the Federal Reserve Economic Data website (FRED) download the civilian unemployment rate (series ID UNRATE). The unemployment rate should be at a monthly frequency, seasonally adjusted and for the period 1954:01-2019:12
    1. Plot the unemployment rate and the spread (BAA-AAA) Compute the correlation coefficient between the two series over the entire sample. Please report this.
    2. Run the following regression:

 

  1. Where is the spread (BAA-AAA) that you have created before,  is the unemployment rate, and  is the error term. Report coefficient estimates, standard errors, and R2.  Comment on the results obtained (max 250 words).
  2. Equation 3 above suggests you that high interest rate spreads are a consequence, rather than a cause of high unemployment. Is this interpretation plausible? What are the limitations of testing this hypothesis using Equation 3? (max 250 words).