Tractable Almost Stochastic Dominance

Tractable Almost Stochastic Dominance

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Article ID: iaor20121350
Volume: 218
Issue: 2
Start Page Number: 448
End Page Number: 455
Publication Date: Apr 2012
Journal: European Journal of Operational Research
Authors: ,
Keywords: programming: linear, investment
Abstract:

LL‐Almost Stochastic Dominance (LL‐ASD) is a relaxation of the Stochastic Dominance (SD) concept proposed by Leshno and Levy that explains more of realistic preferences observed in practice than SD alone does. Unfortunately, numerical applications of this concept, such as identifying if a given portfolio is efficient or determining a marketed portfolio that dominates a given benchmark, are computationally prohibitive due to the structure of LL‐ASD. We propose a new Almost Stochastic Dominance (ASD) concept that is computationally tractable. For instance, a marketed dominating portfolio can be identified by solving a simple linear programming problem. Moreover, the new concept performs well on all the intuitive examples from the literature, and in some cases leads to more realistic predictions than the earlier concept. We develop some properties of ASD, formulate efficient optimization models, and apply the concept to analyzing investors’ preferences between bonds and stocks for the long run.

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