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- Title
THE STATISTICAL VALIDITY OF THE RATIO METHOD IN FINANCIAL ANALYSIS: AN EMPIRICAL EXAMINATION.
- Authors
McDonald, Bill; Morris, Michael H.
- Abstract
This article examines the validity of financial ratio analysis through comparison with alternative specifications. Given the ubiquitous application of ratio analysis in business by both practitioners and academicians, there is a dearth of corresponding theoretical and empirical research to support this method. Ratio analysis has been popularized not by its structural validity, but by its convenience. The regression specification analogous to the ratio method differs from the standard bivariate form because of the assumption of proportionality. The proportional relationship of the ratio method implies a purely heteroscedastic form. The ratio method can be tested with respect to the assumption of proportionality and the inclusion of an intercept term using the series of models labeled OLS, OLS-A, PRO and PRO-A. The proportionality assumption of the ratio method is assayed by testing for heteroscedasticity in each of the four regression models. Ratio analysis in its most common application involves the cross-sectional comparison of a particular firm with an industry standard.
- Subjects
CORPORATE finance; FINANCIAL ratios; FINANCIAL performance; CREDIT ratings; INVESTMENT analysis; EXPECTED returns
- Publication
Journal of Business Finance & Accounting, 1984, Vol 11, Issue 1, p89
- ISSN
0306-686X
- Publication type
Article
- DOI
10.1111/j.1468-5957.1984.tb00059.x