Merton Henriksson Timing Test | Definition

Merton Henriksson Timing Test

Merton Henriksson Timing Test | Definition

In Russell Style Classification (RSC), an analysis used to determine whether a manager has any market timing ability. The standard regression is supplemented with a term that mimics the payoff to free puts. If the market is zero or down, the payoff is zero; and when the market is up, the payoff is the market return. This payoff pattern is captured in the second term of the regression below. Assuming a given risk-free proxy, the standard Capital Asset Pricing Model (CAPM) regression is modified to include interaction terms for upside market return.

When the timing coefficient is greater than zero and is statistically significant that means that the portfolio has market timing ability which is desirable. Conversely, when the timing coefficient is negative or zero and is not statistically significant that means that the portfolio does not have timing ability or their timing ability is perverse which is undesirable. Note that the alpha is likely to change because we are using more information than in the standard regression.

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