Journal of Banking & Finance Vol. 137 2022
Optimal portfolio choice for higher-order risk averters
Abstract
The effects of higher-order risk aversion on optimal cross-sectional portfolio choice are investigated using portfolio optimization with Stochastic Dominance constraints. Tractable sufficient conditions for higher-degree dominance are introduced that take the form of a system of linear inequalities. Existing studies of active equity industry rotation are extended from lower degrees to higher degrees of dominance. Fourth-degree dominance assumes that investors are ‘prudent’ and ‘temperate’ and therefore like skewness and dislike kurtosis. Using this dominance criterion leads to superior out-of-sample investment performance, by allowing for more concentration in recent winner industries which tend to show persistent positive abnormal returns and a favorable higher-order risk profile due to the industry-level price momentum effect.
- DOI
- 10.1016/j.jbankfin.2022.106429
- Volume
- 137
- Pages
- 106429
- Language
- en
- Sources
- openalex crossref bibtex:phds-export.bib