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Improved Portfolio Choice using Second-Order Stochastic Dominance

Listed author(s):
  • James E. Hodder


    (University of Wisconsin-Madinson)

  • Jens Carsten Jackwerth


    (Department of Economics, University of Konstanz, Germany)

  • Olga Kolokolova


    (University of Manchester, United Kingdom)

We examine the use of second-order stochastic dominance as both a way to measure performance and also as a technique for constructing portfolios. Using in-sample data, we construct portfolios such that their second-order stochastic dominance over a typical pension fund benchmark is most probable. The empirical results based on 21 years of daily data suggest that this portfolio choice technique significantly outperforms the benchmark portfolio out-of-sample. As a preference-free technique it will also suit any risk-averse investor in e.g. a pension fund. Moreover, its out-of-sample performance across eight different measures is superior to widely discussed portfolio choice approaches such as equal weights, mean variance, and minimum-variance methods.

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Paper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2010-14.

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Length: 55 pages
Date of creation: 11 Nov 2010
Handle: RePEc:knz:dpteco:1014
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