The Bond Equity Yield Ratio : An investigation of its forecasting ability in Denmark, Finland, Norway and Sweden

Abstract: Scientists and practitioners have for decades attempted to find methods to forecast movements in the capital markets, thereby trying to find a way to outperform the market. The origins of forecasting literature investigated traditional financial and accounting ratios such as the dividend yield (D/P) and the earnings yield (E/P). A more recent development in the literature is an investigation of the information content inherent in the relationship between bond yields and equity yields. Based on the belief that government bonds and stocks are seen as competing assets by investors, a model known as the Bond Equity Yield Ratio has evolved. The BEYR compares the yields of the two assets and thus signals when the yield of one asset might be overpriced in relation to the yield of the other. The existing stream of literature has focused its attention towards mainly two capital markets, the US and the UK. Previous studies have often examined the forecasting ability by applying regression approaches or looking at extreme thresholds of the BEYR distribution, providing mixed results. Following the objectivistic path of ontology and the positivistic epistemology, the purpose of this study is to extend the existing knowledge laid out in the preceding literature. By examining the information content provided by the BEYR in the capital markets of Denmark, Finland, Norway and Sweden further evidence of its forecasting ability will be provided. Using historical data to compute the BEYR and following the switching signals provided, the performance of actively managed portfolios containing bonds or stocks will be compared to the market portfolio. Hence, this study tests the weak form of the efficient market hypothesis in Denmark, Finland, Norway and Sweden, via a deductive approach. The findings presented in this paper show that during the observation period, following a BEYR strategy would have led to excess return over the market portfolio in all four markets. Additionally, the BEYR portfolios had greater Sharpe ratios than those of the market portfolio, indicating better risk adjusted returns and thus a sounder relationship between risk and return. However, failing to be statistically significant, these results are only indications of potential positive effects of utilizing a BEYR strategy. Consequently, the weak form of the efficient market hypothesis seems to hold in the capital markets of Denmark, Finland, Norway and Sweden.