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Harmonic analysis, time series variations and the distributional properties of financial ratios

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  • Fuller-Love, N.
  • Rhys, H.
  • Tippett, M.

Abstract

This paper models the behaviour of financial ratios using the techniques of continuous time stochastic calculus. Previous work in the area has been restricted to models based on first order stochastic differential equations. However, in the present paper we model a ratio's displacement from its long term mean in terms of a second order stochastic differential equation. In this way we show that higher order equations may be used to provide more flexible modelling procedures than those previously studied. The paper begins by describing a ratio's evolution in terms of a particular form of second order stochastic differential equation. A solution is then obtained for this equation. We then show how the parameters of the model may be estimated from a given set of empirical data. The model is then applied to a data set of four ratios for 118 UK companies covering a period of 37 years. For three of the four ratios, clear evidence of a period emerges. Previous work suggests that these ratios are well described by mean reversion processes. Our empirical analysis, however, suggests there is a significant tendency for adjustments to 'overshoot' the targeted long term mean. Taken together with prior work in the area, the paper begins to provide a broad picture of the way in which financial ratios evolve over time.

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  • Fuller-Love, N. & Rhys, H. & Tippett, M., 1995. "Harmonic analysis, time series variations and the distributional properties of financial ratios," Omega, Elsevier, vol. 23(4), pages 419-427, August.
    • Handle: RePEc:eee:jomega:v:23:y:1995:i:4:p:419-427
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    References listed on IDEAS

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    Cited by:

    1. David Ashton & Paul Dunmore & Mark Tippett, 2004. "Double Entry Bookkeeping and the Distributional Properties of a Firm's Financial Ratios," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(5-6), pages 583-606.
    2. T H Moon & S Y Sohn, 2011. "Survival analysis for technology credit scoring adjusting total perception," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 62(6), pages 1159-1168, June.
    3. David Ashton & Paul Dunmore & Mark Tippett, 2004. "Double Entry Bookkeeping and the Distributional Properties of a Firm's Financial Ratios," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(5‐6), pages 583-606, June.
    4. Moon, Tae Hee & Sohn, So Young, 2008. "Technology scoring model for reflecting evaluator's perception within confidence limits," European Journal of Operational Research, Elsevier, vol. 184(3), pages 981-989, February.
    5. Barniv, Ran & Mehrez, Abraham & Kline, Douglas M., 2000. "Confidence intervals for controlling the probability of bankruptcy," Omega, Elsevier, vol. 28(5), pages 555-565, October.

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