Stochastic Bounds for Reference Sets in Portfolio Analysis

Abstract

A stochastic bound is a portfolio which stochastically dominates all alternatives in a reference portfolio set instead of a single alternative portfolio. An approximate bound is a portfolio which comes as close as possible to this ideal. To identify and analyze exact or approximate bounds, feasible approaches to numerical optimization and statistical inference are developed based on Linear Programming and subsampling. The use of reference sets and stochastic bounds is shown to improve investment performance in representative applications to enhanced benchmarking using equity industry rotation and equity index options combinations.

Keywords: Portfolio Analysis, Stochastic Dominance, Subsampling, Linear Programming, Enhanced Benchmarking

JEL Classification: C61, D81, G11