Generalized DEA model of fundamental analysis and its application to portfolio optimization |
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Authors: | NCP Edirisinghe X Zhang |
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Institution: | Department of Statistics, Operations, and Management Science, College of Business Administration, University of Tennessee, Knoxville, TN 37996, USA |
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Abstract: | Fundamental analysis is used in asset selection for equity portfolio management. In this paper, a generalized data envelopment analysis (DEA) model is developed to analyze a firm’s financial statements over time in order to determine a relative financial strength indicator (RFSI) that is predictive of firm’s stock price returns. RFSI is based on maximizing the correlation between the DEA-based score of financial strength and the stock market performance. This maximization involves a difficult binary nonlinear program that requires iterative re-configuration of parameters of financial statements as inputs and outputs. We utilize a two-step heuristic algorithm that combines random sampling and local search optimization. The proposed approach is tested with 230 firms from various US technology-industries to determine optimized RFSI indicators for stock selection. Then, those selected stocks are used within portfolio optimization models to demonstrate the usefulness of the scheme for portfolio risk management. |
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Keywords: | C61 C67 G11 |
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