Asset Prices and Omitted Moments; a Stochastic Dominance Analysis of Market Efficiency

Abstract

We analyze if the value-weighted stock market portfolio is second-order stochastic dominance (SSD) efficient relative to benchmark portfolios formed on market capitalization, book-to-market equity ratio and industry classification. During the period from the mid-1970s to the late 1980s, the market portfolio is significantly mean-variance inefficient. During this period, the market portfolio generally also is significantly SSD inefficient. This suggests that mean-variance inefficiency cannot be explained by omitted return moments like higher-order central moments or lower partial moments.

Keywords: stochastic dominance, market efficiency, asset pricing, statistical inference, size and book-to-market effects

JEL Classification: M, M41, G3, C19, G12