Modelling fundamental analysis in portfolio selection

Huazhu Zhang and Cheng Yan

Quantitative Finance, 2018, vol. 18, issue 8, 1315-1326

Abstract: We derive a closed-form appraisal/information ratio of the investors who are able to observe some information about security fundamentals, by solving a simple instantaneous mean-variance portfolio choice problem in a continuous-time framework. Both analytical and numerical results suggest that investors should choose securities with a more volatile mispricing, a less volatile fundamental, a higher mean-reverting speed and a larger dividend. Our model calibrated with realistic parameters easily outperforms top-percentile portfolio managers in reality, which suggests that the implementation of fundamental analysis may be impeded in practice due to limits of arbitrage. Our paper is a first, necessarily simple, step towards filling the gap of modelling fundamental analysis in portfolio selection.

Date: 2018
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DOI: 10.1080/14697688.2017.1418520

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