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Stochastic Spanning

Listed author(s):
  • Stelios Arvanitis
  • Mark Hallam
  • Thierry Post

    ()

    (Graduate School of Business, Koç University)

This study develops and implements a theory and method for analyzing whether introducing new securities or relaxing investment constraints improves the investment opportunity set for risk averse investors. We develop a test procedure for ‘stochastic spanning’ for two nested polyhedral portfolio sets based on subsampling and Linear Programming. The procedure is statistically consistent and asymptotically exact for a class of weakly dependent processes. Using the stochastic spanning tests, we accept market portfolio efficiency but reject two-fund separation in standard data sets of historical stock market returns. The divergence between the results of the two tests illustrates the role for higher-order moment risk in portfolio choice and challenges representative-investor models of capital market equilibrium.

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File URL: http://eaf.ku.edu.tr/sites/eaf.ku.edu.tr/files/erf_wp_1505.pdf
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Paper provided by Koc University-TUSIAD Economic Research Forum in its series Koç University-TUSIAD Economic Research Forum Working Papers with number 1505.

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Length: 28 pages
Date of creation: Apr 2015
Handle: RePEc:koc:wpaper:1505
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  1. Oliver Linton & Esfandiar Maasoumi & Yoon-Jae Whang, 2005. "Consistent Testing for Stochastic Dominance under General Sampling Schemes," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 735-765.
  2. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
  3. Garry F. Barrett & Stephen G. Donald, 2003. "Consistent Tests for Stochastic Dominance," Econometrica, Econometric Society, vol. 71(1), pages 71-104, January.
  4. Thierry Post, 2003. "Empirical Tests for Stochastic Dominance Efficiency," Journal of Finance, American Finance Association, vol. 58(5), pages 1905-1932, October.
  5. Stephen A. Ross, 2005. "Mutual Fund Separation in Financial Theory—The Separating Distributions," World Scientific Book Chapters,in: Theory Of Valuation, chapter 10, pages 309-356 World Scientific Publishing Co. Pte. Ltd..
  6. Huberman, Gur & Kandel, Shmuel, 1987. " Mean-Variance Spanning," Journal of Finance, American Finance Association, vol. 42(4), pages 873-888, September.
  7. J. Tobin, 1958. "Liquidity Preference as Behavior Towards Risk," Review of Economic Studies, Oxford University Press, vol. 25(2), pages 65-86.
  8. James P. Quirk & Rubin Saposnik, 1962. "Admissibility and Measurable Utility Functions," Review of Economic Studies, Oxford University Press, vol. 29(2), pages 140-146.
  9. Scaillet, Olivier & Topaloglou, Nikolas, 2010. "Testing for Stochastic Dominance Efficiency," Journal of Business & Economic Statistics, American Statistical Association, vol. 28(1), pages 169-180.
  10. Hadar, Josef & Russell, William R, 1969. "Rules for Ordering Uncertain Prospects," American Economic Review, American Economic Association, vol. 59(1), pages 25-34, March.
  11. Russell Davidson & Jean-Yves Duclos, 2000. "Statistical Inference for Stochastic Dominance and for the Measurement of Poverty and Inequality," Econometrica, Econometric Society, vol. 68(6), pages 1435-1464, November.
  12. Robert F. Dittmar, 2002. "Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 57(1), pages 369-403, 02.
  13. Timo Kuosmanen, 2004. "Efficient Diversification According to Stochastic Dominance Criteria," Management Science, INFORMS, vol. 50(10), pages 1390-1406, October.
  14. Bawa, Vijay S., 1975. "Optimal rules for ordering uncertain prospects," Journal of Financial Economics, Elsevier, vol. 2(1), pages 95-121, March.
  15. Post, Thierry & Versijp, Philippe, 2007. "Multivariate Tests for Stochastic Dominance Efficiency of a Given Portfolio," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(02), pages 489-515, June.
  16. Oliver Linton & Thierry Post & Yoon‐Jae Whang, 2014. "Testing for the stochastic dominance efficiency of a given portfolio," Econometrics Journal, Royal Economic Society, vol. 17(2), pages 59-74, 06.
  17. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-1152, September.
  18. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-317, June.
  19. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, 06.
  20. Ali, Mukhtar M., 1975. "Stochastic dominance and portfolio analysis," Journal of Financial Economics, Elsevier, vol. 2(2), pages 205-229, June.
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