Using statistical and neural network methods to explore the relationship between systematic risk and firm's long term investment activities

Abstract

The paper presents a neural network method to explore the relationship between the systematic risk and long term investing activities for Taiwan's companies in the fiber industry and electronics industry. In general, diversification from long-term investment may reduce a firm's systematic risk, but the empirical results in some literature are controversial. For years regression methods have been used to analyze the possible impact of long-term investment activities on systematic risk. Since their relationship may not be linear, we thus propose a neural network based sensitivity analysis for the possible non-linear relationships. We adapt five years of data (1994-1998) from the TEJ financial database to conduct the proposed analysis. The results show that the systematic risk is reduced with investment activities for the fiber industry. But for the electronics industry, the systematic risk is higher as firms increase the long-term investment ratio. The difference is even more significant when we only consider the companies with a higher portion of long term investment in assets. This diverse effect between industries may be one of the reasons why the empirical results are inconsistent. Our study can clarify the controversy between the systematic risk and long-term investment activities, and offer some possible explanations.