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Portfolio selection under DEA-based relative financial strength indicators: case of US industries

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  • N C P Edirisinghe

    (The University of Tennessee)

  • X Zhang

    (The University of Tennessee)

Abstract

Fundamental analysis is an approach for evaluating a firm for its investment-worthiness whereby the firm's financial statements are subject to detailed investigation to predict future stock price performance. In this paper, we propose an approach to combine financial statement data using Data Envelopment Analysis to determine a relative financial strength (RFS) indicator. Such an indicator captures a firm's fundamental strength or competitiveness in comparison to all other firms in the industry/market segment. By analysing the correlation of the RFS indicator with the historical stock price returns within the industry, a well-informed assessment can be made about considering the firm in an equity portfolio. We test the proposed indicator with firms from the technology sector, using various US industries and report correlation analyses. Our preliminary computations using RFS indicator-based stock selection within mean–variance portfolio optimization demonstrate the validity of the proposed approach.

Suggested Citation

  • N C P Edirisinghe & X Zhang, 2008. "Portfolio selection under DEA-based relative financial strength indicators: case of US industries," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 59(6), pages 842-856, June.
    • Handle: RePEc:pal:jorsoc:v:59:y:2008:i:6:d:10.1057_palgrave.jors.2602442
    DOI: 10.1057/palgrave.jors.2602442
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    2. Kerstens, Kristiaan & Mounir, Amine & Van de Woestyne, Ignace, 2010. "Benchmarking Mean-Variance Portfolios. Using a Shortage Function: The Choice of Direction Vector," Working Papers 2010/01, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.
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    4. Edirisinghe, N.C.P. & Zhang, X., 2010. "Input/output selection in DEA under expert information, with application to financial markets," European Journal of Operational Research, Elsevier, vol. 207(3), pages 1669-1678, December.
    5. Lim, Sungmook & Oh, Kwang Wuk & Zhu, Joe, 2014. "Use of DEA cross-efficiency evaluation in portfolio selection: An application to Korean stock market," European Journal of Operational Research, Elsevier, vol. 236(1), pages 361-368.
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    9. Vrinda Dhingra & Amita Sharma & Shiv K. Gupta, 2021. "Sectoral portfolio optimization by judicious selection of financial ratios via PCA," Papers 2106.11484, arXiv.org, revised Jan 2023.
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