Abstract
Starting from the reward-risk model for portfolio selection introduced in De Giorgi (2005), we derive the reward-risk Capital Asset Pricing Model (CAPM) analogously to the classical mean-variance CAPM. In contrast to the mean-variance model, reward-risk portfolio selection arises from an axiomatic definition of reward and risk measures based on a few basic principles, including consistency with second-order stochastic dominance. With complete markets, we show that at any financial market equilibrium, reward-risk investors' optimal allocations are comonotonic and, therefore, our model reduces to a representative investor model. Moreover, the pricing kernel is an explicitly given, non-increasing function of the market portfolio return, reflecting the representative investor's risk attitude. Finally, an empirical application shows that the reward-risk CAPM captures the cross section of U.S. stock returns better than the mean-variance CAPM does.
| Original language | English |
|---|---|
| Pages (from-to) | 525-546 |
| Number of pages | 22 |
| Journal | Journal of Financial and Quantitative Analysis |
| Volume | 43 |
| Issue number | 2 |
| Publication status | Published - Jun 2008 |
| Externally published | Yes |
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ASJC Scopus subject areas
- Finance
- Accounting
- Economics and Econometrics
Cite this
Second-order stochastic dominance, reward-risk portfolio selection, and the CAPM. / De Giorgi, Enrico; Post, Thierry.
In: Journal of Financial and Quantitative Analysis, Vol. 43, No. 2, 06.2008, p. 525-546.Research output: Contribution to journal › Article
}
TY - JOUR
T1 - Second-order stochastic dominance, reward-risk portfolio selection, and the CAPM
AU - De Giorgi, Enrico
AU - Post, Thierry
PY - 2008/6
Y1 - 2008/6
N2 - Starting from the reward-risk model for portfolio selection introduced in De Giorgi (2005), we derive the reward-risk Capital Asset Pricing Model (CAPM) analogously to the classical mean-variance CAPM. In contrast to the mean-variance model, reward-risk portfolio selection arises from an axiomatic definition of reward and risk measures based on a few basic principles, including consistency with second-order stochastic dominance. With complete markets, we show that at any financial market equilibrium, reward-risk investors' optimal allocations are comonotonic and, therefore, our model reduces to a representative investor model. Moreover, the pricing kernel is an explicitly given, non-increasing function of the market portfolio return, reflecting the representative investor's risk attitude. Finally, an empirical application shows that the reward-risk CAPM captures the cross section of U.S. stock returns better than the mean-variance CAPM does.
AB - Starting from the reward-risk model for portfolio selection introduced in De Giorgi (2005), we derive the reward-risk Capital Asset Pricing Model (CAPM) analogously to the classical mean-variance CAPM. In contrast to the mean-variance model, reward-risk portfolio selection arises from an axiomatic definition of reward and risk measures based on a few basic principles, including consistency with second-order stochastic dominance. With complete markets, we show that at any financial market equilibrium, reward-risk investors' optimal allocations are comonotonic and, therefore, our model reduces to a representative investor model. Moreover, the pricing kernel is an explicitly given, non-increasing function of the market portfolio return, reflecting the representative investor's risk attitude. Finally, an empirical application shows that the reward-risk CAPM captures the cross section of U.S. stock returns better than the mean-variance CAPM does.
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UR - http://www.scopus.com/inward/citedby.url?scp=46849110164&partnerID=8YFLogxK
M3 - Article
VL - 43
SP - 525
EP - 546
JO - Journal of Financial and Quantitative Analysis
JF - Journal of Financial and Quantitative Analysis
SN - 0022-1090
IS - 2
ER -