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Improved Portfolio Choice using Second-Order Stochastic Dominance

Author

Listed:
  • James E. Hodder

    (University of Wisconsin-Madinson)

  • Jens Carsten Jackwerth

    (Department of Economics, University of Konstanz, Germany)

  • Olga Kolokolova

    (University of Manchester, United Kingdom)

Abstract

We examine the use of second-order stochastic dominance as both a way to measure performance and also as a technique for constructing portfolios. Using in-sample data, we construct portfolios such that their second-order stochastic dominance over a typical pension fund benchmark is most probable. The empirical results based on 21 years of daily data suggest that this portfolio choice technique significantly outperforms the benchmark portfolio out-of-sample. As a preference-free technique it will also suit any risk-averse investor in e.g. a pension fund. Moreover, its out-of-sample performance across eight different measures is superior to widely discussed portfolio choice approaches such as equal weights, mean variance, and minimum-variance methods.

Suggested Citation

  • James E. Hodder & Jens Carsten Jackwerth & Olga Kolokolova, 2010. "Improved Portfolio Choice using Second-Order Stochastic Dominance," Working Paper Series of the Department of Economics, University of Konstanz 2010-14, Department of Economics, University of Konstanz.
    • Handle: RePEc:knz:dpteco:1014
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    File URL: http://www.uni-konstanz.de/FuF/wiwi/workingpaperseries/WP_Hodder-Jackwerth-Kolokolova-14-10.pdf
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    References listed on IDEAS

    as
    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

    Keywords

    second-order stochastic dominance; portfolio choice; portfolio measurement;
    All these keywords.

    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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