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Correcting the Merton and Henriksson timing model

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  • Luis Ferruz
  • Fernando Munoz
  • Maria Vargas

Abstract

This article provides evidence of a common bias found in traditional timing models, which is related with a negative correlation between timing and stock-picking abilities resulting in spurious coefficients. We consider as a possible cause for this bias the failure to include in the timing models the cost of the option implied in timing activities, and on this basis we opt for a corrected version of the Merton and Henriksson's model (1981). As far as we know, this correction has not previously been applied. Our results confirm both the existence of this bias and the correction of the problem when the cost of the option is included in timing models.

Suggested Citation

  • Luis Ferruz & Fernando Munoz & Maria Vargas, 2010. "Correcting the Merton and Henriksson timing model," Applied Economics Letters, Taylor & Francis Journals, vol. 17(12), pages 1183-1187.
    • Handle: RePEc:taf:apeclt:v:17:y:2010:i:12:p:1183-1187
    DOI: 10.1080/00036840902845384
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    References listed on IDEAS

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    1. Henriksson, Roy D & Merton, Robert C, 1981. "On Market Timing and Investment Performance. II. Statistical Procedures for Evaluating Forecasting Skills," The Journal of Business, University of Chicago Press, vol. 54(4), pages 513-533, October.
    2. François-Serge LHABITANT, 2001. "On Swiss Timing and Selectivity: In the Quest of Alpha," FAME Research Paper Series rp27, International Center for Financial Asset Management and Engineering.
    3. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    4. Nicolas P. B. Bollen & Jeffrey A. Busse, 2001. "On the Timing Ability of Mutual Fund Managers," Journal of Finance, American Finance Association, vol. 56(3), pages 1075-1094, June.
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