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Improved Portfolio Choice Using Second Order Stochastic Dominance

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<mark>Journal publication date</mark>31/07/2015
<mark>Journal</mark>Review of Finance
Issue number4
Volume19
Number of pages25
Pages (from-to)1623-1647
Publication StatusPublished
<mark>Original language</mark>English

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.