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Stochastic Dominance over Potential Portfolios: Caution Regarding Covariance
Author(s) -
McCarl Bruce A.,
Knight Thomas O.,
Wilson James R.,
Hastie James B.
Publication year - 1987
Publication title -
american journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.949
H-Index - 111
eISSN - 1467-8276
pISSN - 0002-9092
DOI - 10.2307/1242191
Subject(s) - stochastic dominance , covariance , econometrics , normality , dominance (genetics) , portfolio , mathematics , statistics , economics , financial economics , biochemistry , chemistry , gene
Stochastic dominance historically has been applied to the pair‐wise comparison of alternatives. However, difficulties can arise when the alternatives are not mutually exclusive but can be used to form portfolio strategies. In such cases rules can be derived based on normality and the distribution moments. In general, the pure alternatives may be compared as long as the correlation coefficient exceeds the ratio of the standard errors less a potential correction for the difference between the means. The rules inherent in the last statement were empirically verified using normal, uniform, and beta distributions and empirical data. Results indicated that the rules were highly reliable but conservative.