A researcher is interested in identifying day of the week effects in the returns on BA, a company
traded in the UK. Note that stocks are traded only five days a week. She collects a sample of
returns on BA and a sample of returns on the FTSE100 index for the same time period. Then she
creates five dummy variables, D1,t, D2,t, D3,t, D4,t, D5,t , one for day of the week . D1,t takes value one
on Monday and zero on any other day of the week and the other dummies are defined similarly for
the other days of the week. Explain why the model
rt =alpha +eta rt
M + gamma 1D1t + gamma 2D2t + gamma 3D3t + gamma 4D4t + gamma 5D5t + ut
suffers from perfect multicollinearity. Write down two different specifications of the model that allow
for seasonality effects without causing perfect multicollinearity. Interpret the parameters of t both
models.A researcher is interested in identifying day of the week effects in the returns on BA, a company
traded in the UK. Note that stocks are traded only five days a week. She collects a sample of
returns on BA and a sample of returns on the FTSE100 index for the same time period. Then she
creates five dummy variables, D_(1,t),D_(2,t),D_(3,t),D_(4,t),D_(5,t), one for day of the week . D_(1,t) takes value one
on Monday and zero on any other day of the week and the other dummies are defined similarly for
the other days of the week. Explain why the model
r_(t)=alpha +eta r_(t)^(M)+Y_(1)D_(1t)+Y_(2)D_(2t)+Y_(3)D_(3t)+Y_(4)D_(4t)+Y_(5)D_(5t)+u_(t)
suffers from perfect multicollinearity. Write down two different specifications of the model that allow
for seasonality effects without causing perfect multicollinearity. Interpret the parameters of t both
models.
A researcher is interested in identifying day of the week effects in the returns on BA, a company traded in the UK.Note that stocks are traded only five days a week.She collects a sample of returns on BA and a sample of returns on the FTSE100 index for the same time period. Then she creates five dummy variables, D1,t, D2.t, D3.t, D4.t, D5.t , one for day of the week . D1,t takes value one on Monday and zero on any other day of the week and the other dummies are defined similarly for the other days of the week. Explain why the model rt=a +3 rtM + V1D1t +V 2D2t + V3D3t + V4D4t + V5D5t + Ut suffers from perfect multicollinearity. Write down two different specifications of the model that allow for seasonality effects without causing perfect multicollinearity. Interpret the parameters of t both models.