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Improved Portfolio Choice Using Second-Order Stochastic Dominance

Author

Listed:
  • James E. Hodder
  • Jens Carsten Jackwerth
  • Olga Kolokolova

Abstract

Constructing portfolios based on second-order stochastic dominance (SSD) is theoretically attractive since all risk-averse investors would prefer a dominating portfolio. However, choosing among SSD efficient portfolios is a challenge without an obvious ranking metric. We explore particular choices based on Kuosmanen (2004) plus Kopa and Post (2011), comparing their performance to other SSD-related strategies and to standard portfolio choice approaches. These SSD-related choices outperform portfolios chosen based on their Sharpe ratio, information ratio, or using equal weights. Portfolios based on minimum variance that also match the benchmark’s mean return perform on a par with the SSD-related choices.

Suggested Citation

  • James E. Hodder & Jens Carsten Jackwerth & Olga Kolokolova, 2015. "Improved Portfolio Choice Using Second-Order Stochastic Dominance," Review of Finance, European Finance Association, vol. 19(4), pages 1623-1647.
    • Handle: RePEc:oup:revfin:v:19:y:2015:i:4:p:1623-1647.
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    File URL: http://hdl.handle.net/10.1093/rof/rfu025
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    References listed on IDEAS

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    1. Fishburn, Peter C, 1977. "Mean-Risk Analysis with Risk Associated with Below-Target Returns," American Economic Review, American Economic Association, vol. 67(2), pages 116-126, March.
    2. Russell Davidson, 2009. "Testing for Restricted Stochastic Dominance: Some Further Results," Review of Economic Analysis, Digital Initiatives at the University of Waterloo Library, vol. 1(1), pages 34-59, September.
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G - Financial Economics

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