A portfolio optimality test based on the first-order stochastic dominance criterion

Miloš Kopa, Thierry Post

Research output: Contribution to journalArticlepeer-review

32 Citations (Scopus)


Existing approaches to testing for the efficiency of a given portfolio make strong parametric assumptions about investor preferences and return distributions. Stochastic dominance-based procedures promise a useful nonparametric alternative. However, these procedures have been limited to considering binary choices. In this paper we take a new approach that considers all diversified portfolios and thereby introduce a new concept of first-order stochastic dominance (FSD) optimality of a given portfolio relative to all possible portfolios. Using our new test, we show that the U.S. stock market portfolio is significantly FSD nonoptimal relative to benchmark portfolios formed on market capitalization and book-to-market equity ratios. Without appealing to parametric assumptions about the return distribution, we conclude that no nonsatiable investor would hold the market portfolio in the face of the attractive premia of small caps and value stocks.

Original languageEnglish
Pages (from-to)1103-1124
Number of pages22
JournalJournal of Financial and Quantitative Analysis
Issue number5
Publication statusPublished - Oct 2009

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics


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