Improved Portfolio Choice Using Second Order Stochastic Dominance

Abstract

This paper examines the use of second-order stochastic dominance as both a way to measure portfolio performance relative to a benchmark and also as a technique for constructing portfolios. Using in-sample data, we construct portfolios such that their dominance over a typical pension fund benchmark is maximized. The empirical results based on 20 years of daily data suggest that this portfolio choice technique significantly outperforms the benchmark portfolio out-of-sample. Moreover, its performance is superior to mean-variance and equally weighted portfolio choice approaches.