Testing for Prospect and Markowitz stochastic dominance efficiency

Stelios Arvanitis and Nikolas Topalogou
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Stelios Arvanitis: Athens University of Economics and Business
Nikolas Topalogou: Athens University of Economics and Business

No 201701, Working Papers from Athens University Of Economics and Business, Department of Economics

Abstract: We develop non-parametric tests for prospect stochastic dominance Efficiency (PSDE) and Markowitz stochastic dominance efficiency (MSDE) using block bootstrap resampling. Under the appropriate conditions we show that they are a symptotically conservative and consistent. We employ Monte Carlo experiments to assess the finite sample size and power of the tests. We use the tests to empirically establish whether the value-weighted market portfolio is the best choice of every individual with preferences exhibiting certain patterns of local attitudes to- wards risk. Our results indicate that we cannot reject the hypothesis of prospect stochastic dominance efficiency for the market portfolio. This is supportive of the claim that the par- ticular portfolio can be rationalized as the optimal choice for any S-shaped utility function. Instead,we reject the hypothesis forMarkowitz stochastic dominance,which could imply that there exist reverse S-shaped utility functions that do not rationalize the market portfolio.

Keywords: Nonparametrictest; prospect stochastic dominance efficiency; Markowitz stochastic dominance efficiency; simplical complex; extremal point; Linear Programming; Mixed In- teger Programming; Block Bootstrap; Consistency. (search for similar items in EconPapers)
JEL-codes: C12 C13 C15 C44 D81 G11 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2017-01
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Citations: View citations in EconPapers (10)

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