Investment strategies in dynamic economies
: application of the Bakshi Chen Dong valuation model on a sample of 25 stocks

  • Ayline Sarkis (Student)

Student thesis: Master's Thesis

Abstract

This dissertation studies the effectiveness of the Bakshi-Chen-Dong (2001) valuation model (BCD) in selecting stocks for investment. The BCD model has a closed-form solution where the firm’s equilibrium stock price is a function of its (1) current net earnings per share, (2) expected growth of earnings, and (3) current interest rates. A stock is deemed mispriced whenever the percentage difference between the model price and the actual market value of the stock is far from zero. The performance of this mispricing measure in picking profitable stocks is compared to three indirect valuation indicators (earnings-to-price, size, and past return momentum) in the case of 25 stocks in the Dow Jones Industrial Average Index of 2022. First, alike Dong (2000), the mispricing measure is shown to be close to zero, and mean-reverting every ten months, allowing for potentially profitable trades. Second, when taken explicitly, exploiting the model mispricing is proven to be the most profitable strategy in picking stocks for investment over a one-month time horizon. Finally, a strategy that combines high momentum stocks with low mispricing showed the best performance among all studied.
Date of Award25 Jan 2024
Original languageEnglish
Awarding Institution
  • Universidade Católica Portuguesa
SupervisorNuno Silva (Supervisor)

Keywords

  • Stock valuation
  • BCD model
  • Mispricing
  • Earnings-to-price
  • Size
  • Momentum
  • Return
  • Investment
  • Underpriced
  • Overpriced

Designation

  • Mestrado em Finanças

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