Stochastic Dominance in Mutual Fund Returns
52 Pages Posted: 12 Mar 2020 Last revised: 20 May 2020
Date Written: February 19, 2020
We find that a large portion of U.S. equity mutual funds almost second-order stochastically dominates the market portfolio. Consistent with the canonical definition of second-order stochastic dominance, both fund investors and managers reveal their preference for funds with a higher degree of almost second-order stochastic dominance through higher inflows and higher manager ownership. Funds with a higher degree of stochastic dominance over the market portfolio significantly outperform their peers, after controlling for common performance predictors and the Sharpe ratio. Inference based on stochastic dominance is more consistent with the Manipulation-Proof Performance Measure (MPPM) than with the Sharpe ratio.
Keywords: stochastic dominance, Sharpe ratio, mutual fund performance
JEL Classification: G11, G23
Suggested Citation: Suggested Citation