Tests in investments, Financial Management

Assignment Help:

Tests in Investments

There are many rules that specify how the past data of share prices can be used to obtain a clue regarding the future prices of shares. Such rules would be valuable to an investor because they could be used to determine which share prices are likely to rise. Hence the investor could buy such share and sell them in future at a higher price thereby earning a profit.

Statistical tests have been applied to examine whether such rules can deliver what they promise. Can investors using these rules earn higher profits than investors not using these rules? Do these rules really provide clues about the future prices of shares? Are short-term share price fluctuations not random in nature? Below are the results of two tests applied to past data of share prices to ascertain whether such data has any information relevant to future share price estimates.

Serial Correlation Tests

We have studied correlation applied to pairs of observations. For example, we can find out the correlation of one share price with another share's price, or the correlation of one company's share price with the company's profits.

In auto-correlation we ascertain the correlation of current observations in a set with past observations of the same set. As applied to investments, serial correlation has been used to find the correlation coefficient between current changes in a share's price and past changes in the same share's price. It was found that the correlation coefficient was very near to zero. If current share price changes are uncorrelated with past share price changes, how can the rules based on a study of past share prices have any predictive value?

Runs Tests

Correlation coefficients are unduly influenced by extreme observations. It was argued that a few unrepresentative extreme observations may have distorted the results of the above Serial Correlation Tests. So Runs Tests were devised. Here, only the directions of share price changes were considered. As the magnitudes of price changes were ignored, the excessive influence of extreme observations was removed.

In a typical Runs Test the changes in share prices may be classified as '+' meaning an increase and '-' meaning a decrease. A run is said to last as long as the price changes do not change direction. For example, given the following daily price changes of a share, we can identify three runs.

1249_runs test.png

So Runs Tests also appear to support the conclusion that share price changes are random.Runs Tests reveal that the number of runs are nearly equal to the runs that would be expected if share price changes were random.


Related Discussions:- Tests in investments

What is a financial ratio, What is a financial ratio? A financial rati...

What is a financial ratio? A financial ratio is a number that convey the value of one financial variable relative to another.  Put more easily, a financial ratio is the final

M.r, capital structure

capital structure

Interest rate anticipation strategies, Active bond management depends...

Active bond management depends on an economic scenario in order to forecast the movements of yield curve. A portfolio manager skillfully builds a portfolio wit

Describe the walters dividend model, Q. Describe the Walters dividend model...

Q. Describe the Walters dividend model? Walter's Model: - Walter's model maintains the doctrine that the dividend policy is relevant for the value of the firm. As-per to the Wa

Determination of credit terms, Determination of Credit Terms:- The sec...

Determination of Credit Terms:- The second feature of receivable management, subsequent to setting the credit standards and assessment of credit worthiness of the customers, i

Explain cross border acquisitions and green field investment, Why do you th...

Why do you think the host country tends to resist cross-border acquisitions, rather as compared to green field investments? Answer: The host country is inclined to view green f

What are the limitations of trade payable day''s ratio, What are the Limita...

What are the Limitations oftrade payable day's ratio? Year-end trade payables may not be representative of the year. Credit purchases are VAT exclusive in the income sta

FINANCIAL RISK MGT, DQ #1: Discuss the challenges of VaR approaches in valu...

DQ #1: Discuss the challenges of VaR approaches in valuing risk. How does portfolio risk assessment differ from a single asset’s risk assessment? How do managers typically load ba

Use of beta to partition risk, Use of Beta to Partition Risk The total ...

Use of Beta to Partition Risk The total risk or variability in earnings can be attributed to two classes of factors: Marketwide factors which create variability in all

Foreign exchange rates, Foreign Exchange Rates The proportional va...

Foreign Exchange Rates The proportional value of one currency to other, used to exchange currency from one denomination to another.  For example, one British pound is wort

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd