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New Development on the Third Order Stochastic Dominance for Risk-Averse and Risk-Seeking Investors with Application in Risk Management

Author

Listed:
  • Raymond H. Chan

    (Department of Mathematics, City University of Hong Kong)

  • Xu Guo

    (School of Statistics, Beijing Normal University)

  • Ephraim Clark

    (Middlesex Business School)

  • Wing-Keung Wong

    (Department of Finance, Fintech Center, and Big Data Research Center, Asia University| Department of Medical Research, China Medical University Hospital|Department of Economics and Finance,T The Hang Seng University of Hong Kong)

Abstract

This paper develops new financial theory to link the third order stochastic dominance for risk-averse and risk-seeking investors and provide illustration of application in risk management. We present some interesting new properties of third order stochastic dominance (TSD) for risk-averse and risk-seeking investors. We show that the means of the assets being compared should be included in the definition of TSD for both investor types. We also derive the conditions on the variance order of two assets with equal means for both investor types and extend the second order SD (SSD)reversal result of Levy and Levy (2002) to TSD. We apply our results to analyze the investment behaviors on traditional stocks and internet stocks for both risk averters and risk seekers.

Suggested Citation

  • Raymond H. Chan & Xu Guo & Ephraim Clark & Wing-Keung Wong, 2020. "New Development on the Third Order Stochastic Dominance for Risk-Averse and Risk-Seeking Investors with Application in Risk Management," Economic Growth Centre Working Paper Series 2002, Nanyang Technological University, School of Social Sciences, Economic Growth Centre.
    • Handle: RePEc:nan:wpaper:2002
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    File URL: https://web.hss.ntu.edu.sg/egc/wp/2020/2020-02.pdf
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    JEL classification:

    • C00 - Mathematical and Quantitative Methods - - General - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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