Testing for central dominance: Method and application

O-Chia Chuang, Chung-Ming Kuan () and Larry Y. Tzeng

Journal of Econometrics, 2017, vol. 196, issue 2, 368-378

Abstract: Central dominance (CD) introduced in Gollier (1995, Journal of Economic Theory) is a risk concept that differs from stochastic dominance (SD) in an important way. In particular, CD implies a deterministic comparative static of a change in decision when risk changes, but SD does not have such an implication. In this paper, we propose the first test of central dominance, which amounts to checking a functional inequality. We derive the asymptotic distribution of a lower bound of the proposed test and suggest a bootstrap procedure to compute the critical values. We also conduct simulations to evaluate the performance of this test. Our empirical study finds clear evidence of CD relations between the S&P 500 index return distributions during 2001–2013 and results in unambiguous implications for investment decisions.

Keywords: Central dominance; Contact set; Functional inequality; Stochastic dominance; Portfolio selection (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:196:y:2017:i:2:p:368-378

DOI: 10.1016/j.jeconom.2016.07.008

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