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Empirical Tests for Stochastic Dominance Efficiency

Authors

  • Thierry Post

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    • Post is an Associate Professor of Finance at the Erasmus University Rotterdam in the Netherlands. This study forms part of a research program on stochastic dominance. Details on the program are available at the program homepage http://www.few.eur.nl/few/people/gtpost/stochastic_dominance.htm. I would like to express my appreciation to Martijn van den Assem, Alan Genz, Timo Kuosmanen, Haim Levy, and Jaap Spronk, as well as the editor, Rick Green, and two anonymous referees, for providing helpful comments and stimulating discussion. I gratefully acknowledge financial support by Tinbergen Institute and Erasmus Research Institute of Management. Any remaining errors are my own.


Abstract

We derive empirical tests for the stochastic dominance efficiency of a given portfolio with respect to all possible portfolios constructed from a set of assets. The tests can be computed using straightforward linear programming. Bootstrapping techniques and asymptotic distribution theory can approximate the sampling properties of the test results and allow for statistical inference. Our results could provide a stimulus to the further proliferation of stochastic dominance for the problem of portfolio selection and evaluation. Using our tests, the Fama and French market portfolio is significantly inefficient relative to benchmark portfolios formed on market capitalization and book-to-market equity ratio.

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