3/27/10

Modeling share prices of financial companies: LM

(continued)

The model for Legg Mason (LM) is based on the index of food and beverages (F) and the index of appliances (APL) from the housing index, leading by 4 and 13 months, respectively Overall, the predicted time series is very close to the observed one with standard deviation of $7.03 between July 2003 and February 2010. The largest input to the standard deviation comes from a short period in 2006. Otherwise, both curves are very close even during the dramatic fall from $80 per share in the end of 2007 to $10 per share in February 2009 and during the fast recovery in 2009.

So, the best-fit 2-C model for AXP(t) is as follows:

LM(t)= -5.77F(t-4) – 8.44APL(t-13) + 31.25(t-2000) + 1743.5

The predicted curve should lead the observed price by 4 months. In other words, the price of a LM share is completely defined by the behaviour of the two CPI components. Figure 1 depicts the observed and predicted prices, the latter shifted four months back for synchronization.

The model does predict the share price. Therefore, it should be revisited at a monthly basis. In March and April 2010, the price is expected at $30 and $33, respectively. On 26th of March, the price was at $29.5. However, the predicted curve shows a sudden fall to the level of $22 in May/June 2010.

Figure 1. Observed and predicted LM share prices.

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