Making Inefficient Market Indices Efficient

24 Pages Posted: 9 Feb 2009

See all articles by Ephraim Clark

Ephraim Clark

Middlesex University Business School

Octave Jokung

EDHEC Business School

Konstantinos Kassimatis

Athens University of Economics and Business - Department of Business Administration

Date Written: February 9, 2009

Abstract

The concept of efficient portfolios plays an important role in modern financial theory and practice. Although there is an extensive and growing literature that focuses on testing portfolio efficiency, outside of mean-variance optimization, which has several serious shortcomings, no systematic methodology for building efficient portfolios from inefficient indices has been developed. This paper addresses this issue. It uses the concept of Marginal Conditional Stochastic Dominance and a generalization of the 50% Portfolio Rule to develop a tractable and parsimonious methodology for constructing an efficient portfolio from a given, inefficient index. Because the Stochastic Dominance (SD) approach considers the entire probability distributions of asset returns, the resulting portfolios are efficient with respect to all risk-averse, non-satiable investors regardless of the form of their utility functions or the distributions of asset returns.

Keywords: Stochastic Dominance, Portfolio Efficiency

JEL Classification: G10, G11

Suggested Citation

Clark, Ephraim and Jokung, Octave and Kassimatis, Konstantinos, Making Inefficient Market Indices Efficient (February 9, 2009). Available at SSRN: https://ssrn.com/abstract=1339804 or http://dx.doi.org/10.2139/ssrn.1339804

Ephraim Clark

Middlesex University Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

Octave Jokung

EDHEC Business School ( email )

58, rue du Port
Department of Economics and Finance
59046 Lille Cedex
France
33(0)320154536 (Phone)
33(0)320154501 (Fax)

Konstantinos Kassimatis (Contact Author)

Athens University of Economics and Business - Department of Business Administration ( email )

Athens
Greece

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