Linear Versus Non‐linear Relationships Between Financial Ratios and Stock Returns: Empirical Evidence from Egyptian Firms

Abstract

Even though most previous research studies suggest that the relationship between common financial ratios and stock returns is linear, recent studies by Mramor and Mramor‐Kosta (1997), and Mramor and Pahor (1998) show that such a linear relationship might not generally exist. In this study, we model the relationships between common financial ratios and stock returns from 1996 to 2000 using linear and non‐linear forms for a sample of 46 Egyptian firms. Our empirical findings suggest that non‐linear relationships exist and are more descriptive of the behavior of stock returns.