Optimal portfolio choice for higher-order risk averters

Yi Fang and Thierry Post

Journal of Banking & Finance, 2022, vol. 137, issue C

Abstract: The effects of higher-order risk aversion on optimal cross-sectional portfolio choice are investigated using portfolio optimization with Stochastic Dominance constraints. Tractable sufficient conditions for higher-degree dominance are introduced that take the form of a system of linear inequalities. Existing studies of active equity industry rotation are extended from lower degrees to higher degrees of dominance. Fourth-degree dominance assumes that investors are ‘prudent’ and ‘temperate’ and therefore like skewness and dislike kurtosis. Using this dominance criterion leads to superior out-of-sample investment performance, by allowing for more concentration in recent winner industries which tend to show persistent positive abnormal returns and a favorable higher-order risk profile due to the industry-level price momentum effect.

Keywords: Portfolio choice; Higher-order risk; Portfolio optimization; Linear programming; Active portfolio management (search for similar items in EconPapers)
JEL-codes: C61 D81 G11 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:137:y:2022:i:c:s0378426622000292

DOI: 10.1016/j.jbankfin.2022.106429

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