Testing downside risk efficiency under market distress

Jose Olmo
Authors registered in the RePEc Author Service: Jesus Gonzalo

UC3M Working papers. Economics from Universidad Carlos III de Madrid. Departamento de Economía

Abstract: In moments of distress downside risk measures like Lower Partial Moments (LPM) are more appropriate than the standard variance to characterize risk. The goal of this paper is to study how to compare portfolios in these situations. In order to do that we show the close connection between mean-risk efficiency sets and stochastic dominance under distress episodes of the market, and use the latter property to propose a hypothesis test to discriminate between portfolios across risk aversion levels. Our novel family of test statistics for testing stochastic dominance under distress makes allowance for testing orders of dominance higher than zero, for general forms of dependence between portfolios and can be extended to residuals of regression models. These results are illustrated in the empirical application for data from US stocks. We show that mean-variance strategies are stochastically dominated by mean-risk efficient sets in episodes of financial distress.

Keywords: Stochastic; dominance; Comovements; Downside; risk; Lower; partial; moments; Market; Distress; Mean-risk; models; Mean-variance; models (search for similar items in EconPapers)
JEL-codes: C1 C2 (search for similar items in EconPapers)
Date: 2008-09
New Economics Papers: this item is included in nep-ecm and nep-rmg
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Related works:
Working Paper: Testing Downside Risk Efficiency Under Market Distress (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:cte:werepe:we084321

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