Download This PaperNew Development on the Third Order Stochastic Dominance for Risk-Averse and Risk-Seeking Investors with Application in Risk Management
57 Pages Posted: 6 Jan 2019 Last revised: 1 May 2020
Date Written: December 16, 2018
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.
Keywords: Third order stochastic dominance, expected-utility maximization, risk aversion, risk seeking, investment behaviors
JEL Classification: C00, G11
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