Modeling growth stocks (part II)

Continuing the previous work on growth stocks, we propose a diffusion model for growth stocks. Since growth stocks tend to have low or even negative earnings and high volatility, it is a great challenge to derive a meaningful mathematical model within the traditional valuation framework. The diffusion model not only has economic interpretations for its parameters, but also leads to some interesting economic insight - the model postulates mean reversion (with a high mean reverting level) for growth stocks, which could be useful in understanding the recent boom and bust of the "Internet bubble". Simulation and an empirical evaluation of the model based on the size distribution are also presented. The simulation and numerical results are quite encouraging.