Reward-Risk Portfolio Selection and Stochastic Dominance

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Reward-Risk Portfolio Selection and Stochastic Dominance

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Enrico De Giorgi

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Enrico Giovanni De Giorgi

Abstract

The portfolio selection problem is traditionally modelled by two different approaches. The first one is based on an axiomatic model of risk-averse preferences, where decision makers are assumed to possess an expected utility function and the portfolio choice consists in maximizing the expected utility over the set of feasible portfolios. The second approach, first proposed by Markowitz (1952), is very intuitive and reduces the portfolio choice to a set of two criteria, reward and risk, with possible tradeoff analysis. Usually the reward-risk model is not consistent with the first approach, even when the decision is independent from the specific form of the risk-averse expected utility function, i.e. when one investment dominates another one by second order stochastic dominance. In this paper we generalize the reward-risk model for portfolio selection. We define reward measures and risk measures by giving a set of properties these measures should satisfy. One of these properties will be the consistency with second order stochastic dominance, to obtain a link with the expected utility portfolio selection. We characterize reward and risk measures and we discuss the implication for portfolio selection.

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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number iewwp121.

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Article
- De Giorgi, Enrico, 2005. "Reward-risk portfolio selection and stochastic dominance," Journal of Banking & Finance, Elsevier, vol. 29(4), pages 895-926, April. [Downloadable!] (restricted)

Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

This paper has been announced in the following NEP Reports:

NEP-ALL-2002-08-19 (All new papers)
NEP-FIN-2002-08-19 (Finance)

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

De Giorgi, Enrico, 2005. "Reward-risk portfolio selection and stochastic dominance," Journal of Banking & Finance, Elsevier, vol. 29(4), pages 895-926, April. [Downloadable!] (restricted)
Other versions:
- Enrico De Giorgi, . "Reward-Risk Portfolio Selection and Stochastic Dominance," IEW - Working Papers iewwp121, Institute for Empirical Research in Economics - IEW. [Downloadable!]
Bruno S. Frey & Stephan Meier, . "Pro-Social Behavior, Reciprocity or Both?," IEW - Working Papers iewwp107, Institute for Empirical Research in Economics - IEW. [Downloadable!]
Other versions:
- Frey, Bruno S. & Meier, Stephan, 2002. "Pro-Social Behavior, Reciprocity or Both?," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
Lars Feld & Bruno Frey, 2000. "Trust Breeds Trust: How Taxpayers are Treated," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
Other versions:
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- Lars P. Feld & Bruno S. Frey, 2002. "Trust breeds trust: How taxpayers are treated," Economics of Governance, Springer, vol. 3(2), pages 87-99, 07. [Downloadable!] (restricted)
Bruno Frey & Stephan Meier, 2005. "Selfish and Indoctrinated Economists?," European Journal of Law and Economics, Springer, vol. 19(2), pages 165-171, April. [Downloadable!] (restricted)
Other versions:
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Rafael Lalive & Jan C. van Ours & Josef Zweimüller, 2005. "The Effect Of Benefit Sanctions On The Duration Of Unemployment," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1386-1417, December. [Downloadable!] (restricted)
Other versions:
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- Lalive, Rafael & van Ours, Jan C & Zweimüller, Josef, 2002. "The Effect of Benefit Sanctions on the Duration of Unemployment," CEPR Discussion Papers 3311, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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Fehr, Ernst & Klein, Alexander & Schmidt, Klaus M., 2001. "Fairness, Incentives and Contractual Incompleteness," CEPR Discussion Papers 2790, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
Other versions:
- Ernst Fehr & Alexander Klein & Klaus M. Schmidt, . "Fairness, Incentives and Contractual Incompleteness," IEW - Working Papers iewwp072, Institute for Empirical Research in Economics - IEW. [Downloadable!]
- Fehr, Ernst & Klein, Alexander & Schmidt, Klaus M., 2001. "Fairness, Incentives and Contractual Incompleteness," Discussion Papers in Economics 18, University of Munich, Department of Economics. [Downloadable!]
- Ernst Fehr & Alexander Klein & Klaus Schmidt, 2001. "Fairness, Incentives and Contractual Incompleteness," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
Bruno Frey & Alois Stutzer, 2001. "Beyond Bentham -- Measuring Procedural Utility," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
Rabah Amir & Igor V. Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, . "Market Selection and Survival of Investment Strategies," IEW - Working Papers iewwp091, Institute for Empirical Research in Economics - IEW. [Downloadable!]
Other versions:
- R Amir & I Evstigneev & T Hens & K R Schenk-Hoppé, 2002. "Market Selection and Survival of Investment Strategies," The School of Economics Discussion Paper Series 0215, Economics, The University of Manchester. [Downloadable!]
- Rabah Amir & Igor V. Evstigneev & Thorsten Hens & Klaus Reiner Schenk-Hoppé, 2002. "Market Selection and Survival of Investment Strategies," Discussion Papers 02-16, University of Copenhagen. Department of Economics. [Downloadable!]
- Amir, Rabah & Evstigneev, Igor V. & Hens, Thorsten & Schenk-Hoppe, Klaus Reiner, 2005. "Market selection and survival of investment strategies," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 105-122, February. [Downloadable!] (restricted)
Bruno Frey, 2001. "Flexible Citizenship for a Global Society," Berkeley Olin Program in Law & Economics, Working Paper Series 1018, Berkeley Olin Program in Law & Economics. [Downloadable!]
Other versions:
- Bruno S. Frey, . "Flexible Citizenship for a Global Society," IEW - Working Papers iewwp094, Institute for Empirical Research in Economics - IEW. [Downloadable!]

Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Gilbert W. Bassett Jr & Roger Koenker & Gregory Kordas, 2004. "Pessimistic portfolio allocation and Choquet expected utility," CeMMAP working papers CWP09/04, Centre for Microdata Methods and Practice, Institute for Fiscal Studies. [Downloadable!]
Other versions:
- Gilbert W. Bassett, 2004. "Pessimistic Portfolio Allocation and Choquet Expected Utility," Journal of Financial Econometrics, Oxford University Press, vol. 2(4), pages 477-492. [Downloadable!] (restricted)
Polbennikov, Simon & Melenberg, Bertrand, 2005. "Mean-coherent risk and mean-variance approaches in portfolio selection : an empirical comparison," Discussion Paper 100, Tilburg University, Center for Economic Research. [Downloadable!]
Enrico De Giorgi, . "Reward-Risk Portfolio Selection and Stochastic Dominance," IEW - Working Papers iewwp121, Institute for Empirical Research in Economics - IEW. [Downloadable!]
Other versions:
- De Giorgi, Enrico, 2005. "Reward-risk portfolio selection and stochastic dominance," Journal of Banking & Finance, Elsevier, vol. 29(4), pages 895-926, April. [Downloadable!] (restricted)
Melenberg, Bertrand & Polbennikov, Simon, 2005. "Testing for mean-coherent regular risk spanning," Discussion Paper 99, Tilburg University, Center for Economic Research. [Downloadable!]

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