Level-shifts and non-linearity in US financial ratios: Implications for returns predictability and the present value model

David G. McMillan

doi:10.1108/14757701011044198

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Review of Accounting and Finance

ISSN: 1475-7702

Online from: 2002

Subject Area: Accounting and Finance

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Level-shifts and non-linearity in US financial ratios: Implications for returns predictability and the present value model

Document Information:
Title:	Level-shifts and non-linearity in US financial ratios: Implications for returns predictability and the present value model
Author(s):	David G. McMillan, (School of Management, University of St Andrews, St Andrews, UK)
Citation:	David G. McMillan, (2010) "Level-shifts and non-linearity in US financial ratios: Implications for returns predictability and the present value model", Review of Accounting and Finance, Vol. 9 Iss: 2, pp.189 - 207
Keywords:	Company performance, Management ratios, Time series analysis, United States of America
Article type:	Research paper
DOI:	10.1108/14757701011044198 (Permanent URL)
Publisher:	Emerald Group Publishing Limited
Acknowledgements:	JEL classification – C22, G12
Abstract:	Purpose – The recent unprecedented levels reached by financial ratios have led to a re-examination of their time-series properties, with evidence of long memory and nonlinearity reported. The purpose of this paper is to re-examine the nature of these series in the light of potential time-variation in the unconditional mean. Design/methodology/approach – The paper uses econometric techniques designed to capture fractional integration, nonlinearity and time-variation in the unconditional mean level of a series. Findings – Reported results support such time-variation, with cyclical behaviour evident in the unconditional mean of each ratio. Evidence of nonlinearity is still apparent in the mean-adjusted series. Research limitations/implications – A key result that arises is that accounting for this time-variation appears to provide improved long horizon returns predictability. Originality/value – The paper demonstrates that a nonlinear model incorporating a time-varying mean improves returns predictability. This is of interest to market participants.