Publication:
Linear tests for decreasing absolute risk aversion stochastic dominance

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Fang, Yi
Kopa, Milos

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Publication Date

2015

Language

English

Type

Journal Article

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Abstract

We develop and implement linear formulations of convex stochastic dominance relations based on decreasing absolute risk aversion (DARA) for discrete and polyhedral choice sets. Our approach is based on a piecewise-exponential representation of utility and a local linear approximation to the exponentiation of log marginal utility. An empirical application to historical stock market data suggests that a passive stock market portfolio is DARA stochastic dominance inefficient relative to concentrated portfolios of small-cap stocks. The mean-variance rule and Nth-order stochastic dominance rules substantially underestimate the degree of market portfolio inefficiency because they do not penalize the unfavorable skewness of diversified portfolios, in violation of DARA.

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Source:

Management Science

Publisher:

The Institute for Operations Research and the Management Sciences (INFORMS)

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Subject

Management, Operations research, Management science

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