Bst153: Capital Asset Pricing Assessment Answer

ACCOUNTING AND FINANCE

There are two empirical parts to the assignment, which test your understanding of quantitative research methods. The first empirical part is a test of the Capital Asset Pricing Model (CAPM) and Fama-French three-factor asset pricing models using returns of a portfolio including US stocks from a particular industry. The second empirical part is an examination of firm characteristics that may affect audit fees, using a unique sample of UK firms.

PART 1: TEST OF CAPM

Questions:

Use these asset pricing factors to test the validity of the Capital Asset Pricing Model (CAPM) for your industry portfolio returns. Write a detailed commentary to explain the regression models, hypothesis testing, diagnostic tests and analysis of residuals that you are using and interpret your findings.

(a) An explanation of the theories and models being tested with reference to the literature,

(b) A statement of coefficient values under the null hypotheses,

(c) Summary statistics and correlation matrix,

(d) Presentation of regression results,

(e) Interpretation of hypothesis testing on coefficients,

(f) Diagnostic tests to evaluate the goodness of fit of your regression model,

(g) Analysis of residuals to explain the possible bias, demonstrate how these potential

bias may be corrected, and discuss any differences in results after adjusting for the bias.

(h) Any other data, tests, or information that you feel are interesting and relevant.

PART 2: DETERMINANTS OF AUDIT FEES:

Your spreadsheet (AUDITx.csv) contains a random sample of a cross section of 5,000 UK firms. For each firm, you have been provided with the following variables:

(a) log of audit fee (logafee);
(b) log of sales (logsal);
(c) log of total assets (logta);
(d) number of subsidiaries (nsubs);
(e) exports divided by sales (expsales);
(f) total liabilities divided by total assets (gearing) (tlta);
(g) return on total assets (retta);
(h) current assets divided by current liabilities (cacl);
(i) a dummy variable to indicate if the firm’s audit is performed by one of the big
four auditors (big4).

Use the data on the variables listed above to investigate whether firm characteristics explain the cost of the audit. Write a detailed commentary to explain the regression models, hypothesis testing, diagnostic tests and analysis of residuals that you are using and interpret your findings.

(a) An explanation of how and why these variables could explain audit fees,

(b) A statement of coefficient values under null hypotheses,

(c) Summary statistics and correlation matrix,

(d) Presentation of regression results

(e) Interpretation of hypothesis testing on coefficients,

(f) Diagnostic tests to verify the validity of your regression model,

(g) Analysis of residuals (no need check autocorrelation as this is cross-sectional data),

(h) Any other information or tests that you feel are relevant.

PART 3: A CRITICAL EVALUATION OF THE METHOD USED

You are required to critically compare quantitative research methods (i.e., OLS regressions) with qualitative research methods (e.g., case study, interviews, etc.), in terms of validity, reliability, and generalizability. Before the evaluation, you must first define these three concepts with reference to the relevant literature on research methods. three concepts with reference to the relevant literature on research methods. You may also explain whether and how qualitative research methods may be applied in accounting and finance research to address the limitations of quantitative methods. You may also explain briefly the philosophical stances behind these research methods.