Mean-Variance and Stochastic Dominance Analysis of Global Exchange-Traded Funds
46 Pages Posted: 14 Apr 2016
Date Written: April 11, 2016
We employ the stochastic dominance (SD) approach that utilizes the entire return distribution to rank the performance of exchange-traded funds as traditional mean-variance and CAPM approaches may be inappropriate given the nature of non-normal returns. We find second and third-order stochastic dominance relationships amongst the assets and conclude that by investing in higher-order dominant funds, risk-averse investors can maximize their expected utilities but not their wealth. In addition, we find the common characteristic for most pairs of funds is that one fund is preferred to another in the negative domain whereas the preference reverses in the positive domain. We conclude that the stochastic dominance approach is more appropriate compared with traditional approaches as a filter in exchange-traded fund selection. Compared with traditional approaches, the SD approach, not only is assumption free, but also provides greater insights to the performance and risk inherent in an exchange-traded fund’s track record.
Keywords: exchange-traded funds, stochastic dominance, risk-averse investors, performance measurement
JEL Classification: G11, G15
Suggested Citation: Suggested Citation