29 Pages Posted: 9 Mar 2015 Last revised: 23 Oct 2016
Date Written: October 4, 2015
This study develops and implements methods for analyzing whether introducing new securities or relaxing investment constraints improves the investment opportunity set for risk averse investors. We develop a statistical test procedure for ‘stochastic spanning’ for two nested polyhedral portfolio sets based on subsampling and Linear Programming. The test is statistically consistent and asymptotically exact for a class of weakly dependent processes. Using this test, we accept market portfolio efficiency but reject two-fund separation in standard data sets of historical stock market returns. The divergence between the test results for the two hypotheses illustrates the role for higher-order moment risk in portfolio choice and challenges representative-investor models of capital market equilibrium.
Keywords: Portfolio choice, Stochastic Dominance, Spanning, Subsampling, Linear Programming, Asset Pricing
JEL Classification: C61, D81, G11
Suggested Citation: Suggested Citation