Journal of Financial and Quantitative Analysis

Research Article

Multivariate Tests for Stochastic Dominance Efficiency of a Given Portfolio

Thierry Posta1 and Philippe Versijpa2

a1 gtpost@few.eur.nl, Erasmus University Rotterdam, P.O. Box 1738, Rotterdam, DR 3000, The Netherlands.

a2 versijp@few.eur.nl, Erasmus University Rotterdam, P.O. Box 1738, Rotterdam, DR 3000, The Netherlands.

Abstract

We develop empirical tests for stochastic dominance efficiency of a given investment portfolio relative to all possible portfolios formed from a given set of assets. Our tests use multivariate statistics, which result in superior statistical power properties compared to existing stochastic dominance efficiency tests and increase the comparability with existing mean-variance efficiency tests. Using our tests, we demonstrate that the mean-variance inefficiency of the CRSP all-share index relative to beta-sorted portfolios can be explained by tail risk not captured by variance.

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