Stochastic Spanning
29 Pages Posted: 9 Mar 2015 Last revised: 23 Oct 2016
Date Written: October 4, 2015
Abstract
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
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