A Bayesian Approach for Estimating Mean-Standard Deviation Ratios of Financial Data

Abstract

The relation between excess return and risk of financial assets is frequently determined by the mean-standard deviation ratio. Previous research in this matter only derived Point Estimators of this parameter while Inference procedures are currently void. This paper derives a Bayesian procedure for making Inference of this ratio which is easy to apply. Specifically, a method for testing if two ratio coefficients are equal for two independent population segments is derived. This, hence, provides the analyst with a tool for assessing if, e.g. Technique Stocks and Forestry Stocks, have equal risk/return ratio. This paper demonstrates the procedure by an empirical application using data from the Stockholm Stock Exchange.