Learning objectives

Datacamp

• For next week:
  • Just 2 chapters:
    • 1 on linear regression
    • 1 on tidyverse methods
• The full list of Datacamp materials for the course is up on eLearn

R Installation

• If you haven’t already, make sure to install R and R Studio!
  • Instructions are in Session 1’s slides
  • You will need it for this week’s assignment
• Please install a few packages using the following code
  • These packages are also needed for the first assignment
  • You are welcome to explore other packages as well, but those will not be necessary for now

# Run this in the R Console inside RStudio
install.packages(c("tidyverse","plotly","tufte"))

• Assignments will be provided as R Markdown files

The format will generally all be filled out – you will just add to it, answer questions, analyze data, and explain your work. Instructions and hints are in the same file

R Markdown: A quick guide

• Headers and subheaders start with # and ##, respectively
• Code blocks starts with ```{r} and end with ```
  • By default, all code and figures will show up in the document
• Inline code goes in a block starting with `r and ending with `
• Italic font can be used by putting * or _ around text
• Bold font can be used by putting ** around text
  • E.g.: **bold text** becomes bold text
• To render the document, click
• Math can be placed between $ to use LaTeX notation
  • E.g. $\frac{revt}{at}$ becomes \(\frac{revt}{at}\)
• Full equations (on their own line) can be placed between $$
• A block quote is prefixed with >
• For a complete guide, see R Studio’s R Markdown::Cheat Sheet

The question

How can we predict revenue for a company, leveraging data about that company, related companies, and macro factors

More specifically…

• Can we use a company’s own accounting data to predict it’s future revenue?
• Can we use other companies’ accounting data to better predict all of their future revenue?
• Can we augment this data with macro economic data to further improve prediction?
  • Singapore business sentiment data

What is a linear model?

\[ \hat{y}=\alpha + \beta \hat{x} + \varepsilon \]

• The simplest model is trying to predict some outcome \(\hat{y}\) as a function of an input \(\hat{x}\)
  • \(\hat{y}\) in our case is a firm’s revenue in a given year
  • \(\hat{x}\) could be a firm’s assets in a given year
  • \(\alpha\) and \(\beta\) are solved for
  • \(\varepsilon\) is the error in the measurement

I will refer to this as an OLS model – Ordinary Least Square regression

Example

Let’s predict UOL’s revenue for 2016

# revt: Revenue, at: Assets
summary(uol[,c("revt", "at")])

##       revt               at       
##  Min.   :  94.78   Min.   : 1218  
##  1st Qu.: 193.41   1st Qu.: 3044  
##  Median : 427.44   Median : 3478  
##  Mean   : 666.38   Mean   : 5534  
##  3rd Qu.:1058.61   3rd Qu.: 7939  
##  Max.   :2103.15   Max.   :19623

Linear models in R

• To run a linear model, use lm()
  • The first argument is a formula for your model, where ~ is used in place of an equals sign
    • The left side is what you want to predict
    • The right side is inputs for prediction, separated by +
  • The second argument is the data to use
• Additional variations for the formula:
  • Functions transforming inputs (as vectors), such as log()
  • Fully interacting variables using *
    • I.e., A*B includes: A, B, and A times B in the model
  • Interactions using :
    • I.e., A:B only includes A times B in the model

# Example:
lm(revt ~ at, data = uol)

Example: UOL

mod1 <- lm(revt ~ at, data = uol)
summary(mod1)

## 
## Call:
## lm(formula = revt ~ at, data = uol)
## 
## Residuals:
##     Min      1Q  Median      3Q     Max 
## -295.01 -101.29  -41.09   47.17  926.29 
## 
## Coefficients:
##               Estimate Std. Error t value Pr(>|t|)    
## (Intercept) -13.831399  67.491305  -0.205    0.839    
## at            0.122914   0.009678  12.701  6.7e-13 ***
## ---
## Signif. codes:  0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1
## 
## Residual standard error: 221.2 on 27 degrees of freedom
## Multiple R-squared:  0.8566, Adjusted R-squared:  0.8513 
## F-statistic: 161.3 on 1 and 27 DF,  p-value: 6.699e-13

Why is it called Ordinary Least Squares?

Example: UOL

• This model wasn’t so interesting…
  • Bigger firms have more revenue – this is a given
• How about… revenue growth?
• And change in assets
  • i.e., Asset growth

\[ \Delta x_t = \frac{x_t}{x_{t-1}} - 1 \]

Calculating changes in R

• The easiest way is using tidyverse’s dplyr
  • This has a lag() function
• The default way to do it is to create a vector manually

# tidyverse
uol <- uol %>%
  mutate(revt_growth1 = revt / lag(revt) - 1)

# R way
uol$revt_growth2 = uol$revt / c(NA, uol$revt[-length(uol$revt)]) - 1

# Check that both ways are equivalent
identical(uol$revt_growth1, uol$revt_growth2)

## [1] TRUE

You can use whichever you are comfortable with

A note on mutate()

• mutate() adds variables to an existing data frame
  • If you need to manipulate a bunch of columns at once:
    • across() applies a transformation to specified columns in a data frame
    • You can mix in starts_with() or ends_with() to pick columns by pattern
• Mutate can be very powerful when making more complex variables
  • Examples:
    • Calculating growth within company in a multi-company data frame
    • Normalizing data to be within a certain range for multiple variables at once

Example: UOL with changes

# Make the other needed change
uol <- uol %>%
  mutate(at_growth = at / lag(at) - 1) %>%  # Calculate asset growth
  rename(revt_growth = revt_growth1)        # Rename for readability

# Run the OLS model
mod2 <- lm(revt_growth ~ at_growth, data = uol)
summary(mod2)

## 
## Call:
## lm(formula = revt_growth ~ at_growth, data = uol)
## 
## Residuals:
##      Min       1Q   Median       3Q      Max 
## -0.57736 -0.10534 -0.00953  0.15132  0.42284 
## 
## Coefficients:
##             Estimate Std. Error t value Pr(>|t|)  
## (Intercept)  0.09024    0.05620   1.606   0.1204  
## at_growth    0.53821    0.27717   1.942   0.0631 .
## ---
## Signif. codes:  0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1
## 
## Residual standard error: 0.2444 on 26 degrees of freedom
##   (1 observation deleted due to missingness)
## Multiple R-squared:  0.1267, Adjusted R-squared:  0.09307 
## F-statistic: 3.771 on 1 and 26 DF,  p-value: 0.06307

Example: UOL with changes

• \(\Delta\)Assets doesn’t capture \(\Delta\)Revenue so well
• Perhaps change in total assets is a bad choice?
• Or perhaps we need to expand our model?

Scaling up!

\[ \hat{y}=\alpha + \beta_1 \hat{x}_1 + \beta_2 \hat{x}_2 + \ldots + \varepsilon \]

• OLS doesn’t need to be restricted to just 1 input!
  • Not unlimited though (yet – we’ll get there)
    • Number of inputs must be less than the number of observations minus 1
• Each \(\hat{x}_i\) is an input in our model
• Each \(\beta_i\) is something we will solve for
• \(\hat{y}\), \(\alpha\), and \(\varepsilon\) are the same as before

Scaling up our model

We have… 464 variables from Compustat Global alone!

• Let’s just add them all?

Scaling up our model

Building a model requires careful thought!

• This is where having accounting and business knowledge comes in!

What makes sense to add to our model?

Practice: mutate()

• This practice is to make sure you understand how to use mutate with lags
  • These are very important when dealing with business data!
• Do exercises 1 on today’s R practice file:
  • R Practice
  • Shortlink: rmc.link/420r2

Frequentist statistics

A specific test is one of an infinite number of replications

• The “correct” answer should occur most frequently, i.e., with a high probability
• Focus on true vs false
• Treat unknowns as fixed constants to figure out
  • Not random quantities
• Where it’s used
  • Classical statistics methods
    • Like OLS

Bayesian statistics

Focus on distributions and beliefs

• Prior distribution – what is believed before the experiment
• Posterior distribution: an updated belief of the distribution due to the experiment
• Derive distributions of parameters
• Where it’s used:
  • Many machine learning methods
    • Bayesian updating acts as the learning
  • Bayesian statistics

A separate school of statistics thought

Frequentist vs Bayesian methods

Frequentist perspective: Repeat the test

detector <- function() {
  dice <- sample(1:6, size=2, replace=TRUE)
  if (sum(dice) == 12) {
    "exploded"
  } else {
    "still there"
  }
}

experiment <- replicate(1000,detector())
# p value
p <- sum(experiment == "still there") / 1000
if (p < 0.05) {
  paste("p-value: ", p, "-- Fail to reject H_A, sun appears to have exploded")
} else {
  paste("p-value: ", p, "-- Reject H_A that sun exploded")
}

## [1] "p-value:  0.965 -- Reject H_A that sun exploded"

Frequentist: The sun didn’t explode

Bayes persepctive: Bayes rule

\[ P(A|B) = \frac{P(B|A) P(A)}{P(B)} \]

• \(A\): The sun exploded
• \(B\): The detector said it exploded
• \(P(A)\): Really, really small. Say, ~0.
• \(P(B)\): \(\frac{1}{6}\times\frac{1}{6} = \frac{1}{36}\)
• \(P(B|A)\): \(\frac{35}{36}\)

\[ P(A|B) = \frac{P(B|A) P(A)}{P(B)} = \frac{\frac{35}{36}\times\sim 0}{\frac{1}{36}} = 35\times \sim 0 \approx 0 \]

Bayesian: The sun didn’t explode

What analytics typically relies on

• Regression approaches
  • Most often done in a frequentist manner
  • Can be done in a Bayesian manner as well
• Artificial Intelligence
  • Often frequentist
  • Sometimes neither – “It just works”
• Machine learning
  • Sometimes Bayesian, sometime frequentist
  • We’ll see both

We will use both to some extent – for our purposes, we will not debate the merits of either school of thought, but we will use tools derived from both

Confusion from frequentist approaches

• Possible contradictions:
  • \(F\) test says the model is good yet nothing is statistically significant
  • Individual \(p\)-values are good yet the model isn’t
  • One measure says the model is good yet another doesn’t

There are many ways to measure a model, each with their own merits. They don’t always agree, and it’s on us to pick a reasonable measure.

Why formalize?

• Our current approach has been ad hoc
  • What is our goal?
  • How will we know if we have achieved it?
• Formalization provides more rigor

Scientific method

1. Question
   • What are we trying to determine?
2. Hypothesis
   • What do we think will happen? Build a model
3. Prediction
   • What exactly will we test? Formalize model into a statistical approach
4. Testing
   • Test the model
5. Analysis
   • Did it work?

Hypotheses

• Null hypothesis, a.k.a. \(H_0\)
  • The status quo
  • Typically: The model doesn’t work
• Alternative hypothesis, a.k.a. \(H_1\) or \(H_A\)
  • The model does work (and perhaps how it works)
• Frequentist statistics can never directly support \(H_0\)!
  • Only can fail to find support for \(H_A\)
  • Even if our \(p\)-value is 1, we can’t say that the results prove the null hypothesis!

We will use test statistics to test the hypotheses

Regression

• Regression (like OLS) has the following assumptions
  1. The data is generated following some model
     • E.g., a linear model
       • In two weeks, a logistic model
  2. The data conforms to some statistical properties as required by the test
  3. The model coefficients are something to precisely determine
     • I.e., the coefficients are constants
  4. \(p\)-values provide a measure of the chance of an error in a particular aspect of the model
     • For instance, the p-value on \(\beta_1\) in \(y=\alpha + \beta_1 x_1 + \varepsilon\) essentially gives the probability that the sign of \(\beta_1\) is wrong

OLS Statistical properties

\[ \begin{align*} \text{Theory:}\quad y &= \alpha + \beta_1 x_1 + \beta_2 x_2 + \ldots + \varepsilon \\ \text{Data:}\quad \hat{y} &= \alpha + \beta_1 \hat{x}_1 + \beta_2 \hat{x}_2 + \ldots + \hat{\varepsilon} \end{align*} \]

1. There should be a linear relationship between \(y\) and each \(x_i\)
   • I.e., \(y\) is [approximated by] a constant multiple of each \(x_i\)
   • Otherwise we shouldn’t use a linear regression
2. Each \(\hat{x}_i\) is normally distributed
   • Not so important with larger data sets, but a good to adhere to
3. Each observation is independent
   • We’ll violate this one for the sake of causality
4. Homoskedasticity: Variance in errors is constant
   • This is important
5. Not too much multicollinearity
   • Each \(\hat{x}_i\) should be relatively independent from the others
   • Some is OK

Practical implications

Models designed under a frequentist approach can only answer the question of “does this matter?”

• Is this a problem?

What exactly is a linear model?

• Anything OLS is linear
• Many transformations can be recast to linear
  • Ex.: \(log(y) = \alpha + \beta_1 x_1 + \beta_2 x_2 + \beta_3 {x_1}^2 + \beta_4 x_1 \cdot x_2\)
    • This is the same as \(y' = \alpha + \beta_1 x_1 + \beta_2 x_2 + \beta_3 x_3 + \beta_4 x_4\) where:
      • \(y' = log(y)\)
      • \(x_3 = {x_1}^2\)
      • \(x_4 = x_1 \cdot x_2\)

Linear models are very flexible

Mental model of OLS: 1 input

Simple OLS measures a simple linear relationship between an input and an output

• E.g.: Our first regression this week: Revenue on assets

Mental model of OLS: Multiple inputs

OLS measures simple linear relationships between a set of inputs and one output

• E.g.: This is what we did when scaling up earlier this session

Other linear models: IV Regression (2SLS)

IV/2SLS models linear relationships where the effect of some \(x_i\) on \(y\) may be confounded by outside factors.

• E.g.: Modeling the effect of management pay duration (like bond duration) on firms’ choice to issue earnings forecasts
  • Instrument with CEO tenure (Cheng, Cho, and Kim 2015)

Other linear models: SUR

SUR models systems with related error terms

• E.g.: Modeling both revenue and earnings simultaneously

Other linear models: 3SLS

3SLS models systems of equations with related outputs

• E.g.: Modeling stock return, volatility, and volume simultaneously

Other linear models: SEM

SEM can model abstract and multi-level relationships

• E.g.: Showing that organizational commitment leads to higher job satisfaction, not the other way around (Poznanski and Bline 1999)

Modeling choices: Model selection

Pick what fits your problem!

• For forecasting a quantity:
  • Usually some sort of linear model regressed using OLS
  • The other model types mentioned are great for simultaneous forecasting of multiple outputs
• For forecasting a binary outcome:
  • Usually logit or a related model (we’ll start this in 2 weeks)
• For forensics:
  • Usually logit or a related model

There are many more model types though!

Modeling choices: Variable selection

• The options:
  1. Use your own knowledge to select variables
  2. Use a selection model to automate it

Modeling choices: Automated selection

• Traditional methods include:
  • Forward selection: Start with nothing and add variables with the most contribution to Adj \(R^2\) until it stops going up
  • Backward selection: Start with all inputs and remove variables with the worst (negative) contribution to Adj \(R^2\) until it stops going up
  • Stepwise selection: Like forward selection, but drops non-significant predictors
• Newer methods:
  • Lasso and Elastic Net based models
    • Optimize with high penalties for complexity (i.e., # of inputs)
    • We will discuss these in week 5
    • These are proven to be better

The overfitting problem

Or: Why do we like simpler models so much?

• Overfitting happens when a model fits in-sample data too well…
  • To the point where it also models any idiosyncrasies or errors in the data
  • This harms prediction performance
    • Directly harming our forecasts

An overfitted model works really well on its own data, and quite poorly on new data

Coefficients

• In OLS: \(\beta_i\)

P-values

• \(p\)-values tell us the probability that an individual result is due to random chance

“The P value is defined as the probability under the assumption of no effect or no difference (null hypothesis), of obtaining a result equal to or more extreme than what was actually observed.”
– Dahiru 2008

• These are very useful, particularly for a frequentist approach
• First used in the 1700s, but popularized by Ronald Fisher in the 1920s and 1930s

P-values: Rule of thumb

• If \(p<0.05\) and the coefficient sign matches our mental model, we can consider this as supporting our model
  • If \(p<0.05\) but the coefficient is opposite, then it is suggesting a problem with our model
  • If \(p>0.10\), it is rejecting the alternative hypothesis
• If \(0.05 < p < 0.10\) it depends…
  • For a small dataset or a complex problem, we can use \(0.10\) as a cutoff
  • For a huge dataset or a simple problem, we should use \(0.05\)
    • We may even set a lower threshold if we have a ton of data

One vs two tailed tests

• Best practice:
  • Use a two tailed test
• Second best practice:
  • If you use a 1-tailed test, use a p-value cutoff of 0.025 or 0.05
    • This is equivalent to the best practice, just roundabout
• Common but generally inappropriate:
  • Use a one tailed test with cutoffs of 0.05 or 0.10 because your hypothesis is directional

\(R^2\)

• \(R^2\) = Explained variation / Total variation
  • Variation = difference in the observed output variable from its own mean
• A high \(R^2\) indicates that the model fits the data very well
• A low \(R^2\) indicates that the model is missing much of the variation in the output
• \(R^2\) is technically a biased estimator
• Adjusted \(R^2\) downweights \(R^2\) and makes it unbiased
  • \(R^2_{Adj} = P R^2 + 1 - P\)
    • Where \(P=\frac{n-1}{n-p-1}\)
    • \(n\) is the number of observations
    • \(p\) is the number of inputs in the model

Test statistics

• Testing a coefficient:
  • Use a \(t\) or \(z\) test
• Testing a model as a whole
  • \(F\)-test, check adjusted R squared as well
• Testing across models
  • Chi squared (\(\chi^2\)) test
  • Vuong test (comparing \(R^2\))
  • Akaike Information Criterion (AIC) (Comparing MLEs, lower is better)

All of these have p-values, except for AIC

What is causality?

\(A \rightarrow B\)

• Causality is \(A\) causing \(B\)
  • This means more than \(A\) and \(B\) are correlated
• I.e., If \(A\) changes, \(B\) changes. But \(B\) changing doesn’t mean \(A\) changed
  • Unless \(B\) is 100% driven by \(A\)
• Very difficult to determine, particularly for events that happen [almost] simultaneously
• Examples of correlations that aren’t causation

Time and causality

\(A \rightarrow B\) or \(A \leftarrow B\)?

\(A_t \rightarrow B_{t+1}\)

• If there is a separation in time, it’s easier to say \(A\) caused \(B\)
  • Observe \(A\), then see if \(B\) changes after
• Conveniently, we have this structure when forecasting
  • Consider a model like:

\[ Revenue_{t+1} = Revenue_t + \ldots \]

It would be quite difficult for \(Revenue_{t+1}\) to cause \(Revenue_t\)

Time and causality break down

\(A_t \rightarrow B_{t+1}\)? \(\quad\) OR \(\quad\) \(C \rightarrow A_t\) and \(C \rightarrow B_{t+1}\)?

• The above illustrates the Correlated omitted variable problem
  • \(A\) doesn’t cause \(B\)… Instead, some other force \(C\) causes both
  • The bane of social scientists everywhere
• This is less important for predictive analytics, as we care more about performance, but…
  • It can complicate interpreting your results
  • Figuring out \(C\) can help improve you model’s predictions
    • So find C!

Formalizing our last test

Is this model better?

anova(mod2, mod3, test="Chisq")

## Analysis of Variance Table
## 
## Model 1: revt_growth ~ at_growth
## Model 2: revt_growth ~ lct_growth + che_growth + ebit_growth
##   Res.Df    RSS Df Sum of Sq Pr(>Chi)  
## 1     26 1.5534                        
## 2     24 1.1918  2   0.36168   0.0262 *
## ---
## Signif. codes:  0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1

A bit better at \(p<0.05\)

• This means our model with change in current liabilities, cash, and EBIT appears to be better than the model with change in assets.

Expanding our methodology

• Why should we limit ourselves to 1 firm’s data?
• The nature of data analysis is such:

Adding more data usually helps improve predictions

• Assuming:
  • The data isn’t of low quality (too noisy)
  • The data is relevant
  • Any differences can be reasonably controlled for

Expanding our question

• Previously: Can we predict revenue using a firm’s accounting information?
  • This is simultaneous, and thus is not forecasting
• Now: Can we predict future revenue using a firm’s accounting information?
  • By trying to predict ahead, we are now in the realm of forecasting
  • What do we need to change?
    • \(\hat{y}\) will need to be 1 year in the future

First things first

• When using a lot of data, it is important to make sure the data is clean
• In our case, we may want to remove any very small firms

# Ensure firms have at least $1M (local currency), and have revenue
# df contains all real estate companies excluding North America
df_clean <- df %>%
  filter(at>1, revt>0)

# We cleaned out 578 observations!
print(c(nrow(df), nrow(df_clean)))

## [1] 5161 4583

# Another useful cleaning funtion:
# Replaces NaN, Inf, and -Inf with NA for all numeric variables in the data!
df_clean <- df_clean %>%
  mutate_if(is.numeric, list(~replace(., !is.finite(.), NA)))

Looking back at the prior models

uol <- uol %>% mutate(revt_lead = lead(revt))  # From dplyr
forecast1 <- lm(revt_lead ~ lct + che + ebit, data=uol)
library(broom)  # Lets us view bigger regression outputs in a tidy fashion
tidy(forecast1)  # Present regression output

## # A tibble: 4 x 5
##   term        estimate std.error statistic p.value
##   <chr>          <dbl>     <dbl>     <dbl>   <dbl>
## 1 (Intercept)   87.4     124.        0.707  0.486 
## 2 lct            0.213     0.291     0.731  0.472 
## 3 che            0.112     0.349     0.319  0.752 
## 4 ebit           2.49      1.03      2.42   0.0236

glance(forecast1)  # Present regression statistics

## # A tibble: 1 x 12
##   r.squared adj.r.squared sigma statistic    p.value    df logLik   AIC   BIC
##       <dbl>         <dbl> <dbl>     <dbl>      <dbl> <dbl>  <dbl> <dbl> <dbl>
## 1     0.655         0.612  357.      15.2 0.00000939     3  -202.  414.  421.
## # ... with 3 more variables: deviance <dbl>, df.residual <int>, nobs <int>

This model is ok, but we can do better.

Expanding the prior model

forecast2 <- 
  lm(revt_lead ~ revt + act + che + lct + dp + ebit , data=uol)
tidy(forecast2)

## # A tibble: 7 x 5
##   term        estimate std.error statistic p.value
##   <chr>          <dbl>     <dbl>     <dbl>   <dbl>
## 1 (Intercept)  15.6       97.0       0.161 0.874  
## 2 revt          1.49       0.414     3.59  0.00174
## 3 act           0.324      0.165     1.96  0.0629 
## 4 che           0.0401     0.310     0.129 0.898  
## 5 lct          -0.198      0.179    -1.10  0.283  
## 6 dp            3.63       5.42      0.669 0.511  
## 7 ebit         -3.57       1.36     -2.62  0.0161

• Revenue to capture stickiness of revenue
• Current assest & Cash (and equivalents) to capture asset base
• Current liabilities to capture payments due
• Depreciation to capture decrease in real estate asset values
• EBIT to capture operational performance

Expanding the prior model

glance(forecast2)

## # A tibble: 1 x 12
##   r.squared adj.r.squared sigma statistic       p.value    df logLik   AIC   BIC
##       <dbl>         <dbl> <dbl>     <dbl>         <dbl> <dbl>  <dbl> <dbl> <dbl>
## 1     0.903         0.875  203.      32.5 0.00000000141     6  -184.  385.  396.
## # ... with 3 more variables: deviance <dbl>, df.residual <int>, nobs <int>

anova(forecast1, forecast2, test="Chisq")

## Analysis of Variance Table
## 
## Model 1: revt_lead ~ lct + che + ebit
## Model 2: revt_lead ~ revt + act + che + lct + dp + ebit
##   Res.Df     RSS Df Sum of Sq  Pr(>Chi)    
## 1     24 3059182                           
## 2     21  863005  3   2196177 1.477e-11 ***
## ---
## Signif. codes:  0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1

This is better (Adj. \(R^2\), \(\chi^2\), AIC).

Panel data

• Panel data refers to data with the following characteristics:
  • There is a time dimension
  • There is at least 1 other dimension to the data (firm, country, etc.)
• Special cases:
  • A panel where all dimensions have the same number of observations is called balanced
    • Otherwise we call it unbalanced
  • A panel missing the time dimension is cross-sectional
  • A panel missing the other dimension(s) is a time series
• Format:
  • Long: Indexed by all dimensions
  • Wide: Indexed only by some dimensions

Panel data

Data frames are usually wide panels

All Singapore real estate companies

# Note the group_by -- without it, lead() will pull from the subsequent firm!
# ungroup() tells R that we finished grouping
df_clean <- df_clean %>% 
  group_by(isin) %>% 
  mutate(revt_lead = lead(revt)) %>%
  ungroup()

All Singapore real estate companies

forecast3 <-
  lm(revt_lead ~ revt + act + che + lct + dp + ebit,
     data=df_clean[df_clean$fic=="SGP",])
tidy(forecast3)

## # A tibble: 7 x 5
##   term        estimate std.error statistic  p.value
##   <chr>          <dbl>     <dbl>     <dbl>    <dbl>
## 1 (Intercept)  25.0      13.2         1.89 5.95e- 2
## 2 revt          0.505     0.0762      6.63 1.43e-10
## 3 act          -0.0999    0.0545     -1.83 6.78e- 2
## 4 che           0.494     0.155       3.18 1.62e- 3
## 5 lct           0.396     0.0860      4.60 5.95e- 6
## 6 dp            4.46      1.55        2.88 4.21e- 3
## 7 ebit         -0.951     0.271      -3.51 5.18e- 4

All Singapore real estate companies

glance(forecast3)

## # A tibble: 1 x 12
##   r.squared adj.r.squared sigma statistic   p.value    df logLik   AIC   BIC
##       <dbl>         <dbl> <dbl>     <dbl>     <dbl> <dbl>  <dbl> <dbl> <dbl>
## 1     0.844         0.841  210.      291. 2.63e-127     6 -2237. 4489. 4519.
## # ... with 3 more variables: deviance <dbl>, df.residual <int>, nobs <int>

Lower adjusted \(R^2\) – This is worse? Why?

• Note: \(\chi^2\) can only be used for models on the same data
  • Same for AIC

Worldwide real estate companies

forecast4 <-
  lm(revt_lead ~ revt + act + che + lct + dp + ebit , data=df_clean)
tidy(forecast4)

## # A tibble: 7 x 5
##   term         estimate std.error statistic  p.value
##   <chr>           <dbl>     <dbl>     <dbl>    <dbl>
## 1 (Intercept) 222.      585.          0.379 7.04e- 1
## 2 revt          0.997     0.00655   152.    0       
## 3 act          -0.00221   0.00547    -0.403 6.87e- 1
## 4 che          -0.150     0.0299     -5.02  5.36e- 7
## 5 lct           0.0412    0.0113      3.64  2.75e- 4
## 6 dp            1.52      0.184       8.26  1.89e-16
## 7 ebit          0.308     0.0650      4.74  2.25e- 6

Worldwide real estate companies

glance(forecast4)

## # A tibble: 1 x 12
##   r.squared adj.r.squared  sigma statistic p.value    df  logLik    AIC    BIC
##       <dbl>         <dbl>  <dbl>     <dbl>   <dbl> <dbl>   <dbl>  <dbl>  <dbl>
## 1     0.944         0.944 36459.    11299.       0     6 -47819. 95654. 95705.
## # ... with 3 more variables: deviance <dbl>, df.residual <int>, nobs <int>

Higher adjusted \(R^2\) – better!

• Note: \(\chi^2\) can only be used for models on the same data
  • Same for AIC

Model accuracy

Why is the UOL model better than the Singapore model?

• Ranking:
  1. Worldwide real estate model
  2. UOL model
  3. Singapore real estate model

Practice: group_by()

• This practice is to make sure you understand how to use mutate with leads and lags when there are multiple companies in the data
  • We’ll almost always work with multiple companies!
• Do exercises 2 and 3 on today’s R practice file:
  • R Practice
  • Shortlink: rmc.link/420r2

Noise

Statistical noise is random error in the data

• Many sources of noise:
  • Other factors not included in
  • Error in measurement
    • Accounting measurement!
  • Unexpected events / shocks

Noise is OK, but the more we remove, the better!

Removing noise: Singapore model

• Different companies may behave slightly differently
  • Control for this using a Fixed Effect
  • Note: ISIN uniquely identifies companies

forecast3.1 <-
  lm(revt_lead ~ revt + act + che + lct + dp + ebit + factor(isin),
     data=df_clean[df_clean$fic=="SGP",])
# n=7 to prevent outputting every fixed effect
print(tidy(forecast3.1), n=15)

## # A tibble: 27 x 5
##    term                     estimate std.error statistic   p.value
##    <chr>                       <dbl>     <dbl>     <dbl>     <dbl>
##  1 (Intercept)                1.58     39.4       0.0401 0.968    
##  2 revt                       0.392     0.0977    4.01   0.0000754
##  3 act                       -0.0538    0.0602   -0.894  0.372    
##  4 che                        0.304     0.177     1.72   0.0869   
##  5 lct                        0.392     0.0921    4.26   0.0000276
##  6 dp                         4.71      1.73      2.72   0.00687  
##  7 ebit                      -0.851     0.327    -2.60   0.00974  
##  8 factor(isin)SG1AA6000000 218.       76.5       2.85   0.00463  
##  9 factor(isin)SG1AD8000002 -11.7      67.4      -0.174  0.862    
## 10 factor(isin)SG1AE2000006   4.02     79.9       0.0503 0.960    
## 11 factor(isin)SG1AG0000003 -13.6      61.1      -0.223  0.824    
## 12 factor(isin)SG1BG1000000  -0.901    69.5      -0.0130 0.990    
## 13 factor(isin)SG1BI9000008   7.76     64.3       0.121  0.904    
## 14 factor(isin)SG1DE5000007 -10.8      61.1      -0.177  0.860    
## 15 factor(isin)SG1EE1000009  -6.90     66.7      -0.103  0.918    
## # ... with 12 more rows

Removing noise: Singapore model

glance(forecast3.1)

## # A tibble: 1 x 12
##   r.squared adj.r.squared sigma statistic   p.value    df logLik   AIC   BIC
##       <dbl>         <dbl> <dbl>     <dbl>     <dbl> <dbl>  <dbl> <dbl> <dbl>
## 1     0.856         0.844  208.      69.4 1.15e-111    26 -2223. 4502. 4609.
## # ... with 3 more variables: deviance <dbl>, df.residual <int>, nobs <int>

anova(forecast3, forecast3.1, test="Chisq")

## Analysis of Variance Table
## 
## Model 1: revt_lead ~ revt + act + che + lct + dp + ebit
## Model 2: revt_lead ~ revt + act + che + lct + dp + ebit + factor(isin)
##   Res.Df      RSS Df Sum of Sq Pr(>Chi)
## 1    324 14331633                      
## 2    304 13215145 20   1116488   0.1765

This isn’t much different. Why? There is another source of noise within Singapore real estate companies

Another way to do fixed effects

• The library fixest has feols(): fixed effects OLS*
  • Better for complex models
  • Extremely efficient computationally

library(fixest)
forecast3.2 <-
  feols(revt_lead ~ revt + act + che + lct + dp + ebit | isin,
       data=df_clean[df_clean$fic=="SGP",])
summary(forecast3.2)

## OLS estimation, Dep. Var.: revt_lead
## Observations: 331 
## Fixed-effects: isin: 21
## Standard-errors: Clustered (isin) 
##       Estimate Std. Error   t value Pr(>|t|))    
## revt  0.392002   0.188714  2.077200  0.050877 .  
## act  -0.053816   0.154148 -0.349119  0.730649    
## che   0.303696   0.302854  1.002800  0.327946    
## lct   0.392086   0.238711  1.642500  0.116115    
## dp    4.712800   2.630500  1.791600  0.088347 .  
## ebit -0.850798   0.779077 -1.092100  0.287788    
## ---
## Signif. codes:  0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1
## RMSE: 199.8     Adj. R2: 0.843506
##               Within R2: 0.780586

Why exactly would we use fixed effects?

What else can we do?

What else could we do to improve our prediction model?

• Assuming: We have access to any data that is publicly available

For next week

• For next week:
  • 2 chapters on Datacamp
  • First assignment
    • Turn in on eLearn before class in 2 weeks
    • You can work on this in pairs or individually

Packages used for these slides

• broom
• DT
• fixest
• knitr
• magrittr
• plotly
• revealjs
• tidyverse

Custom code

# Graph showing squared error (slide 4.6)
uolg <- uol[,c("at","revt")]
uolg$resid <- mod1$residuals
uolg$xleft <- ifelse(uolg$resid < 0,uolg$at,uolg$at - uolg$resid)
uolg$xright <- ifelse(uolg$resid < 0,uolg$at - uolg$resid, uol$at)
uolg$ytop <- ifelse(uolg$resid < 0,uolg$revt - uolg$resid,uol$revt)
uolg$ybottom <- ifelse(uolg$resid < 0,uolg$revt, uolg$revt - uolg$resid)
uolg$point <- TRUE

uolg2 <- uolg
uolg2$point <- FALSE
uolg2$at <- ifelse(uolg$resid < 0,uolg2$xright,uolg2$xleft)
uolg2$revt <- ifelse(uolg$resid < 0,uolg2$ytop,uolg2$ybottom)

uolg <- rbind(uolg, uolg2)

uolg %>% ggplot(aes(y=revt, x=at, group=point)) + 
         geom_point(aes(shape=point)) + 
         scale_shape_manual(values=c(NA,18)) + 
         geom_smooth(method="lm", se=FALSE) +
         geom_errorbarh(aes(xmax=xright, xmin = xleft)) + 
         geom_errorbar(aes(ymax=ytop, ymin = ybottom)) + 
         theme(legend.position="none")

# Chart of mean revt_lead for Singaporean firms (slide 12.6)
df_clean %>%                                           # Our data frame
  filter(fic=="SGP") %>%                               # Select only Singaporean firms
  group_by(isin) %>%                                   # Group by firm
  mutate(mean_revt_lead=mean(revt_lead, na.rm=T)) %>%  # Determine each firm's mean revenue (lead)
  slice(1) %>%                                         # Take only the first observation for each group
  ungroup() %>%                                        # Ungroup (we don't need groups any more)
  ggplot(aes(x=mean_revt_lead)) +                      # Initialize plot and select data
  geom_histogram(aes(y = ..density..)) +               # Plots the histogram as a density so that geom_density is visible
  geom_density(alpha=.4, fill="#FF6666")               # Plots smoothed density