The Generalized DEA Model of Fundamental Analysis of Public Firms, with Application to Portfolio Selection

Fundamental analysis is an approach for evaluating a public firm for its investmentworthiness by looking at its business at the basic or fundamental financial level. The focus of this thesis is on utilizing financial statement data and a new generalization of the Data Envelopment Analysis, termed the GDEA model, to determine a relative financial strength (RFS) indicator that represents the underlying business strength of a firm. This approach is based on maximizing a correlation metric between GDEA-based score of financial strength and stock price performance. The correlation maximization problem is a difficult binary nonlinear optimization that requires iterative re-configuration of parameters of financial statements as inputs and outputs. A two-step heuristic algorithm that combines random sampling and local search optimization is developed. Theoretical optimality conditions are also derived for checking solutions of the GDEA model. Statistical tests are developed for validating the utility of the RFS indicator for portfolio selection, and the approach is computationally tested and compared with competing approaches.

The GDEA model is also further extended by incorporating Expert Information on input/output selection. In addition to deriving theoretical properties of the model, a new methodology is developed for testing if such exogenous expert knowledge can be significant in obtaining stronger RFS indicators. Finally, the RFS approach under expert information is applied in a Case Study, involving more than 800 firms covering all sectors of the U.S. stock market, to determine optimized RFS indicators for stock selection. Those selected stocks are then used within portfolio optimization models to demonstrate the superiority of the techniques developed in this thesis.