Optimizing Marginal Conditional Stochastic Dominance Portfolios

(Pages: 36-44)

Haim Shalit* and Gleb Gertsman

Department of Economics, Ben-Gurion University of the Negev, Beer-Sheva, Israel.


Marginal Conditional Stochastic Dominance (MCSD) states the probabilistic conditions under which, given a specific portfolio, one risky asset is marginally preferred to another by all risk-averse investors. Furthermore, by increasing the share of dominating assets and reducing the share of dominated assets one can improve the portfo-lio performance for all these investors. We use this standard MCSD model sequentially to build optimal portfolios that are then compared to the optimal portfolios obtained from Chow’s MCSD statistical test model. These portfolios are furthermore compared to the portfolios obtained from the recently developed Almost Marginal Conditional Sto-chastic Dominance (AMCSD) model. The AMCSD model restricts the class of risk-averse investors by not includ-ing extreme case utility functions and reducing the incidence of unrealistic behavior under uncertainty. For each model, an algorithm is developed to manage the various dynamic portfolios traded on the New York, Frankfurt, London, and Tel Aviv stock exchanges during the years 2000-2012. The results show how the various MCSD opti-mal portfolios provide valid investment alternatives to stochastic dominance optimization. MCSD and AMCSD in-vestment models dramatically improve the initial portfolios and accumulate higher returns while the strategy derived from Chow’s statistical test performed poorly and did not yield any positive return..


Finance; Stochastic Dominance; Efficient Portfolios.