Testing Nonlinear Relationships between Excess Rate of Return on Equity and Financial Ratios

12 Pages Posted: 26 Apr 2001

See all articles by Marko Pahor

Marko Pahor

University of Ljubljana - Faculty of Economics

Dusan Mramor

University of Ljubljana - Faculty of Economics

Date Written: April 9, 2001

Abstract

Models that use financial ratios proved to be helpful in decision making of an equity investor. Commonly these models assume linear relationships between a ratio and the rate of return. In this paper the authors test the hypotheses of specific industry independent nonlinear relationships between financial ratios and excess rate of return on equity as defined in Mramor, Mramor Kosta (1996). Mramor, Mramor Kosta tested their hypotheses on financial data of Slovenia for the years 1992 and 1994 and their results were encouraging. However, their tests had three main data problems which may have altered the results: they used proxies for market rates of return on equity of Slovenian companies, they used proxies for risk adjustment of the rates of return and they used data for an economy in transition, where all the market structure and its functioning is not yet developed and stable.In this paper data is used for the stable market economies of the U.S.A. and Japan and direct market measures of the rate of return and risk (CAPM model) were obtained through extensive calculations and adjustments. With this data the second hypothesis of Mramor, Mramor Kosta is tested and the best functional relationships for each financial ratio (within each industry) are determined. The results of the simple regression tests confirm the theoretically assumed relationships and assumed quite strong industry independence of the functional forms of these relationships.

Keywords: Financial ratios; Fundamental analysis; Nonlinear regression

JEL Classification: M49, C21, G12, G30

Suggested Citation

Pahor, Marko and Mramor, Dusan, Testing Nonlinear Relationships between Excess Rate of Return on Equity and Financial Ratios (April 9, 2001). Available at SSRN: https://ssrn.com/abstract=266928 or http://dx.doi.org/10.2139/ssrn.266928

Marko Pahor (Contact Author)

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia
+38615892629 (Phone)
+38615892698 (Fax)

Dusan Mramor

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia
+386 1 589 2400 (Phone)
+386 1 589 2698 (Fax)

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