A GENERALIZATION OF THE NONPARAMETRIC HENRIKSSON-MERTON TEST OF MARKET TIMING

The paper shows that the Henriksson-Merton (1981) test (Journal of Bus iness 54, 513-533) of market timing is better interpreted as an exact test of independence within a 2 x 2 contingency table in which the col umn and row sums are fixed. We provide a generalization of the test of market timing from the special case of a 2 x 2 contingency table to t he case with n categories. This generalization has a number of potenti al applications in the forecasting and finance literature. The general ized test is applied to analyze the market timing performance of a two -fund investment strategy in the presence of transaction costs.