A Complete Ranking of Risky Prospects Consistent with Stochastic Dominance

27 Pages Posted: 14 Dec 2020

See all articles by Olivier Le Courtois

Olivier Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control

Xia Xu

ESSCA School of Management

Date Written: November 12, 2020

Abstract

We introduce a new and complete ordering of prospects that is consistent with stochastic dominance (SD). Featuring loss aversion and skewness preference, it mitigates the low discriminatory power of SD and circumvents implementation difficulties associated with third order SD. To highlight its edge, we show that the Aumann-Serrano and the Foster-Hart general riskiness indicators do not conform to third order SD. The ordering we introduce sheds light on mean variance theory and performance measurement, related SD developments, and optimal diversification. Besides, it contributes to the explanation of Rabin's paradox and reconciles the discrepancy between moment preferences and expected utility theory.

Keywords: Stochastic Dominance, Deficit Scale, Loss Aversion, Skewness Preference

JEL Classification: D01, D81, G11

Suggested Citation

Le Courtois, Olivier Arnaud and Xu, Xia, A Complete Ranking of Risky Prospects Consistent with Stochastic Dominance (November 12, 2020). Available at SSRN: https://ssrn.com/abstract=3729152 or http://dx.doi.org/10.2139/ssrn.3729152

Olivier Arnaud Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control ( email )

23, av. Guy de Collongue
69134 Ecully Cedex
France

Xia Xu (Contact Author)

ESSCA School of Management ( email )

1 avenue Lakanal
Angers, 49000
France

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