TITLE:
LPM Density Functions for the Computation of the SD Efficient Set
AUTHORS:
Fred Viole, David Nawrocki
KEYWORDS:
Stochastic Dominance Algorithm, Lower Partial Moments, Expected Utility Theory, Prospect Theory, Upper Partial Moments
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.6 No.1,
February
26,
2016
ABSTRACT:
The equivalence between partial moments and stochastic dominance dates back to Bawa [1] and Fishburn [2]. We present a test for first, second, and third degree stochastic dominance between two variables using Lower Partial Moments. The results uphold Hadar and Russell’s [3] original conclusions about the odd moments of preferred prospects. We recall Nawrocki’s [4] research comparing Mean/Variance portfolios against the continuum of risk-averse investors using Lower Partial Moments. The excess skewness of the LPM portfolios clearly demonstrates the preference of positive skewness for risk-averse investors. Finally, we provide an algorithm for efficiently determining stochastic dominance efficient sets among large numbers of variables.