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Testing for central dominance: Method and application

Author

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  • Chuang, O-Chia
  • Kuan, Chung-Ming
  • Tzeng, Larry Y.

Abstract

Central dominance (CD) introduced in Gollier (1995, Journal of Economic Theory) is a risk concept that differs from stochastic dominance (SD) in an important way. In particular, CD implies a deterministic comparative static of a change in decision when risk changes, but SD does not have such an implication. In this paper, we propose the first test of central dominance, which amounts to checking a functional inequality. We derive the asymptotic distribution of a lower bound of the proposed test and suggest a bootstrap procedure to compute the critical values. We also conduct simulations to evaluate the performance of this test. Our empirical study finds clear evidence of CD relations between the S&P 500 index return distributions during 2001–2013 and results in unambiguous implications for investment decisions.

Suggested Citation

  • Chuang, O-Chia & Kuan, Chung-Ming & Tzeng, Larry Y., 2017. "Testing for central dominance: Method and application," Journal of Econometrics, Elsevier, vol. 196(2), pages 368-378.
  • Handle: RePEc:eee:econom:v:196:y:2017:i:2:p:368-378
    DOI: 10.1016/j.jeconom.2016.07.008
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