On the Dual Test for Ssd Efficiency: With an Application to Momentum Investment Strategies

Abstract

This paper analyzes the dual formulation of Post's (2003) test for second-order stochastic dominance (SSD) efficiency of a given investment portfolio relative to all possible portfolios formed from a set of assets. In contrast to the earlier work, we (1) provide a direct proof for the dual that does not rely on expected utility theory, (2) adhere to the original definition of SSD, (3) phrase in terms of a general polyhedral portfolio possibilities set and (4) construct a SSD dominating benchmark portfolio from the optimal solution. To illustrate the dual SSD test, we apply the test to analyze the effect of short-selling restrictions on the profitability of momentum investment strategies.

Keywords: Stochastic Dominance, Linear Programming, Investment Analysis, Momentum Strategies

JEL Classification: C63, D81, G11