Testing Stochastic Dominance with Many Conditioning Variables

Oliver Linton, Myung Hwan Seo and Yoon-Jae Whang

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: We propose a test of the hypothesis of conditional stochastic dominance in the presence of many conditioning variables (whose dimension may grow to infinity as the sample size diverges). Our approach builds on a semiparametric location scale model in the sense that the conditional distribution of the outcome given the covariates is characterized by a nonparametric mean function and a nonparametric skedastic function with an independent innovation whose distribution is unknown. We propose to estimate the nonparametric mean and skedastic regression functions by the `1-penalized nonparametric series estimation with thresholding. Under the sparsity assumption, where the number of truly relevant series terms are relatively small (but their identities are unknown), we develop the estimation error bounds for the regression functions and series coefficients estimates allowing for the time series dependence. We derive the asymptotic distribution of the test statistic, which is not pivotal asymptotically, and introduce the smooth stationary bootstrap to approximate its sample distribution. We investigate the finite sample performance of the bootstrap critical values by a set of Monte Carlo simulations. Finally, our method is illustrated by an application to stochastic dominance among portfolio returns given all the past information.

Keywords: Bootstrap; Empirical process; Home bias; LASSO; Power boosting; Sparsity (search for similar items in EconPapers)
JEL-codes: C10 C12 C15 (search for similar items in EconPapers)
Date: 2020-01-14
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-ore
Note: obl20
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Journal Article: Testing stochastic dominance with many conditioning variables (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:2004

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