Modelling the Longitudinal Properties of Financial Ratios of European Firms

44 Pages Posted: 16 Nov 2006

See all articles by Stuart McLeay

Stuart McLeay

University of Sussex; The University of Sydney

Maxwell Stevenson

University of Sydney - School of Business - Finance Discipline; Financial Research Network (FIRN)

Date Written: October 2006

Abstract

The use of financial ratios by analysts to compare the performance of firms from one accounting period to the next is of growing importance with continued European economic integration. Recent studies suggest that the individual component series of financial ratios exhibit nonstationarity which is not eliminated by the ratio transformation. In this paper, we derive a generalised model that incorporates stochastic and deterministic trends and allows for restricted and unrestricted proportionate growth in the ratio numerator and denominator. When the individual firm series are included in a panel structure with large N and small T, we are unable to reject convincingly a joint hypothesis of nonstationarity, whilst in about one third of the individual firm panels there is no evidence of a unit root. Although the components of financial ratios are correlated variables, our estimates show that any cointegrating effects decay rapidly.

Keywords: financial ratios, nonstationarity, proportionate growth, cointegration, panel methods

Suggested Citation

McLeay, Stuart and Stevenson, Max, Modelling the Longitudinal Properties of Financial Ratios of European Firms (October 2006). IIIS Discussion Paper No. 184, Available at SSRN: https://ssrn.com/abstract=945336 or http://dx.doi.org/10.2139/ssrn.945336

Stuart McLeay (Contact Author)

University of Sussex ( email )

Falmer, Brighton BN1 9SL
United Kingdom

The University of Sydney ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

Max Stevenson

University of Sydney - School of Business - Finance Discipline ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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