Multivariate stochastic dominance applied to sector-based portfolio selection

Abstract

Abstract In this study, we investigate whether sector-weighted portfolios based on alternative parametric assumptions are consistent with multivariate stochastic dominance (MSD) conditions for a class of non-satiable risk-averse investors. Focusing specifically on stable symmetric and Student’s t distributions, we propose and motivate an MSD rule to determine a partial order among sectors, based on a comparison between (i) location, (ii) dispersion parameters and (iii) either stability indices (for stable symmetric distributions) or degrees of freedom (for Student’s t distributions). The proposed MSD rule is applied to the US equity market to evaluate whether and how the derived stochastic dominance conditions are relevant to investors’ decisions. The empirical study confirms that the proposed MSD rule is effective and that the tail behaviour of returns is relevant to the optimization of portfolios for non-satiable investors.