Comparison of the multicriteria decision-making methods for equity portfolio selection: The U.S. evidence

Abstract

This paper compares the efficacy of four multicriteria decision-making (MCDM) methods in identifying the future best-performing stocks in two comprehensive samples of U.S. stocks. This is the first time that median-scaling (MS), the Technique for Order Preference by Similarity to an Ideal Solution (TOPSIS), the Analytic Hierarchy Process (AHP), and the additive Data Envelopment Analysis (add.DEA) have been used to combine value and momentum indicators into a single efficiency score. The results show that the MCDM methods examined can successfully be applied to equity portfolio selection. As a robustness check, we repeat all the main sample tests for the sample of the largest-cap stocks included in the two biggest size quintiles (i.e., stocks above 40% NYSE market-cap breakpoint) and find that the overall results are surprisingly robust to size effect. However, the best-performing portfolios formed on the basis of different MCDM methods have remarkably different exposures to the style factors that are commonly used to explain the abnormal returns of active equity portfolios. As a practical implication of this study, investors following certain investing styles could take these different style exposures into account when choosing the MCDM criteria that best fit their portfolio-selection purposes.