Improved Portfolio Choice Using Second Order Stochastic Dominance
41 Pages Posted: 15 Jun 2009 Last revised: 25 Sep 2013
Date Written: September 19, 2013
Constructing portfolios based on second-order stochastic dominance (SSD) is theoretically attractive since all risk-averse investors would prefer a dominating portfolio. However, choosing among SSD efficient portfolios is a challenge without an obvious ranking metric. We explore a particular choice based on Kuosmanen (2004) and compare its performance to other SSD-related strategies and to standard portfolio choice approaches. The SSD-related choices (including the Kuosmanen approach) outperform portfolios based on the Sharpe ratio, equal weights, and the information ratio. Portfolios based on minimum variance that also match the benchmark’s mean return perform on a par with the SSD-related choices.
Keywords: Second-Order Stochastic Dominance, Portfolio Choice, Out-of-Sample Performance, Portfolio Optimization, Performance Measurement
JEL Classification: G11, G23, G12, G13, G14
Suggested Citation: Suggested Citation