In the August 11, 2004 issue of the Wall Street Journal, an article by Eric Engen (resident scholar at the American Enterprise Institute) entitled "Kerry Up, Markets Down" appeared which makes the following claim: "...Sen. Kerry has promised to repeal a significant portion of (the Bush) tax cuts if elected, including the tax rate reductions on dividend and capital gain income. With the growth rate of the economy high but slowing somewhat, there are signs that this promise is rattling financial markets. The evidence suggests that when Sen.Kerry's political fortunes rise, the stock market tanks." Steve Forbes, editor in chief of Forbes and former (Republican) presidential candidate, weighed in with a similar opinion piece (entitled "The Rubinian Candidate") in today's Wall Street Journal.
Mr. Engen's analysis is based upon graphically comparing 5 day moving averages of the 2004 US Presidential "Winner Takes All" Kerry Futures Contract Prices with 5 day moving averages of the S&P 500 index. While it appears that the two time series move in opposite directions, a more convincing analysis requires determining whether what seems visually apparent is statistically significant. Experimental evidence shows that people tend to see order even when the charts they are looking at consist of randomly generated numbers. Therefore, I computed daily returns on the S&P 500 andthe Kerry Futures contract and regressed stock returns on Kerry Futures contract returns for the period June 2, 2004 through August 9, 2004. I selected this period because the datasource (the Iowa Electronic Markets database) has a continuous price history on the Kerry Futures contract which began on June 1, 2004.
The regression equation that I estimated is specified as follows:
r
where
The following table summarizes the regression statistics:
| Regression Statistics | | | | |
| R2 | 0.0680 | | | |
| Observations | 47 (June 2, 2004 through August 9, 2004) | | | |
| | | | | |
| | Coefficients | Standard Error | t Stat | P-value |
| a | -0.0010 | 0.0010 | -0.9972 | 0.3240 |
| b | -0.0389 | 0.0215 | -1.8122 | 0.0766 |
This regression equation has (as one would expect) a relatively low coefficient of determination, or R2 of only .068. In other words, there are other (probably much more) important determinants of stock market returns other than the odds of a Kerry presidency. Furthermore, since 1) the sign of the regression coefficient associated with returns on the Kerry Futures contract is negative, and 2) the correlation coefficient between the dependent and independent variable in a univariate regression equation equals the square root of the coefficient of determination, this implies that the correlation coefficient between returns on the Kerry Futures contract and the S&P500 index is -.26.
Two important questions remain: 1) is the effect statistically significant and 2) is the effect economically significant? The answers to these questions are 1) yes, and 2) no.
Let's look first at the question of statistical significance. Whether a particular independent variable is statistically significant depends upon the P-value associated with its regression coefficient. A regression coefficient's P-value indicates the probability of "Type 1" error. Type 1 error occurs whenever one concludes that a relationship exists when in fact it does not. Furthermore, one must differentiate between "1 tail" and "2 tail" tests. The P-values listed here are for 2 tail tests, meaning that the "null" hypotheses we are trying to reject are
Next, consider the economic significance of the effect. Even though it is statistically significant, the actual magnitude of the effect is quite small. Specifically, on average, a 1 percent change in the value of the Kerry Futures contract is associated with a -0.0389% change in the value of the S&P500 index. Based upon this result, I would have to conclude that Mr. Engen's basis thesis (that when Sen. Kerry's political fortunes rise, the stock market "tanks") does not represent a particularly fair characterization of this relationship. There is an inverse relationship, but the economic significance of the effect is rather negligible.
Dear students,
A very convenient way to keep up with the Options, Futures, and Other Derivatives (OFOD) blog is to receive it as a "news feed". There are several software options available for doing this, many of which are free. I personally prefer a free program called "Pluck". Pluck basically is a "plugin" which integrates itself into Internet Explorer and is therefore very easy to use. Besides Pluck, there are also other free and shareware "standalone" options. I have tried two free programs - "BlogExpress" and "Abilon", and both seem to work just fine. Go to http://www.snapfiles.com/freeware/misctools/fwrssreaders.html for links to these and other free/shareware news reader programs (aka "RSS readers").
Here are some instructions on how to set up your computer to use Pluck:
1. Download "Pluck" by clicking on this link.
2. This will bring up a "file download" dialog box, asking you whether to open or save setup.exe. I recommend that you open this file, which will cause the pluck setup program to be launched.
3. Install the program (by accepting all the defaults).
4. After Pluck is installed, a new Pluck icon will appear in various places; e.g., the Windows taskbar, possibly your desktop, and in the browser. Launch your Internet Explorer Browser, and then launch pluck.
5. You may have to give some private information away in order to get full use of Pluck - go ahead and do this - it is well worth the "price".
6. Go to the OFOD blog, look for the link on the bottom right hand side of the site that says "Syndicate this Site", and click on this link (alternatively, open your browser and go directly to http://129.62.162.212/weblogs/ofod/index.rdf
7. Congratulation! You now are subscribed to the OFOD blog as a "news feed". You can access your news feed any time by activating Pluck, and then clicking on "RSS Reader".
Dear students,
For your convenience, most class materials (except for the textbook) are available from the course website, located at http://129.62.162.212/fin4366. Since most of the links on this website require user authentication, you can authenticate yourself by using your Bear ID as your username and the last four digits of your social security number as your password.
Although I plan to distribute a paper syllabus on the first day of class, in the meantime you may obtain a copy of the syllabus from the class website by using either of the following addresses: http://129.62.162.212/fin4366/syllabus.asp (HTML version) or http://129.62.162.249/ofod/fall2004/fin4366syllabus.pdf (Adobe Acrobat (PDF) Version). Lecture notes for the entire semester are available in PowerPoint and Adobe Acrobat (PDF) file formats. Download whichever version you prefer. These notes can be accessed by clicking on the "Lecture Notes" button on the home page for the class website. I highly recommend that you download and print the lecture notes prior to coming to class, as they will make it much easier for you to follow my lectures. Although the class schedule is subject to change, the lecture notes page effectively serves as a class calendar, since it lists by date the sequencing of course material for the entire semester.
This is the first time that I have used a weblog for the purpose of communicating with my students outside of class. In my view, "blogging" is a better method for doing this than email. If you need to communicate with me via email, send your email to my Baylor address, which is James_Garven@baylor.edu.
Let me know if y'all have any questions. I am looking forward to our first class meeting on Tuesday, August 24.
Sincerely,
Dr. Garven