Explicit Representation of Cost-Efficient Strategies

32 Pages Posted: 22 Oct 2010

See all articles by Carole Bernard

Carole Bernard

Grenoble Ecole de Management; Vrije Universiteit Brussel (VUB)

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics; University of Waterloo

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Date Written: May 12, 2010


This paper uses the preference free framework proposed by Dybvig (1988) and Cox and Leland (1982, 2000) to analyze dynamic portfolio strategies. In general there will be a set of dynamic strategies that have the same payoff distribution. We are able to characterize a lowest cost strategy (a “cost-efficient” strategy) and to give an explicit representation of it. As an application, for any given path-dependent strategy, we show how to construct a financial derivative that dominates in the sense of first-order stochastic dominance. We provide new cost-efficient strategies with the same payoff distributions as some well-known option contracts and this enables us to compute the relative efficiency of these standard contracts. We illustrate the strong connections between cost-efficiency and stochastic dominance.

Keywords: Stochastic Dominance, Efficiency Cost, Expected Utility Optimization, Portfolio Choice

Suggested Citation

Bernard, Carole and Boyle, Phelim P., Explicit Representation of Cost-Efficient Strategies (May 12, 2010). Paris December 2010 Finance Meeting EUROFIDAI - AFFI, Available at SSRN: https://ssrn.com/abstract=1695543

Carole Bernard (Contact Author)

Grenoble Ecole de Management ( email )

12, rue Pierre Sémard
Grenoble Cedex, 38003

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
Brussels, 1050

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
519 884 1970 (Phone)
519 888 1015 (Fax)

University of Waterloo

Waterloo, Ontario N2L 3G1

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