Portfolio Optimization with DARA Stochastic Dominance Constraints
43 Pages Posted: 2 Nov 2017 Last revised: 12 Nov 2018
Date Written: November 1, 2017
An optimization method is developed for constructing investment portfolios which stochastically dominate a given benchmark for all decreasing absolute risk-averse investors, using Quadratic Programming. The method is applied to standard data sets of historical returns of equity price reversal and momentum portfolios. The proposed optimization method improves upon the performance of Mean-Variance optimization by tens to hundreds of basis points per annum, for low to medium risk levels. The improvements critically depend on imposing the complex condition of Decreasing Absolute Risk Aversion in addition to the simpler conditions of global risk aversion and decreasing risk aversion.
Keywords: Portfolio choice, Stochastic Dominance, Decreasing Absolute Risk Aversion, Quadratic Programming, Active investment strategies
JEL Classification: C61, D81, G11
Suggested Citation: Suggested Citation