Journal
EUROPEAN JOURNAL OF OPERATIONAL RESEARCH
Volume 259, Issue 1, Pages 322-329Publisher
ELSEVIER
DOI: 10.1016/j.ejor.2016.10.006
Keywords
Applied probability; Stochastic dominance; Portfolio optimization; Expected shortfall; Index tracking
Funding
- Spanish Ministry of Science and Technology [MTM2013-46962-C2-1-P]
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One recent and promising strategy for Enhanced Indexation is the selection of portfolios that stochastically dominate the benchmark. We propose here a new type of approximate stochastic dominance rule which implies other existing approximate stochastic dominance rules. We then use it to find the portfolio that approximately stochastically dominates a given benchmark with the best possible approximation. Our model is initially formulated as a Linear Program with exponentially many constraints, and then reformulated in a more compact manner so that it can be very efficiently solved in practice. This reformulation also reveals an interesting financial interpretation. We compare our approach with several exact and approximate stochastic dominance models for portfolio selection. An extensive empirical analysis on real and publicly available datasets shows very good out-of-sample performances of our model. (C) 2016 Elsevier B.V. All rights reserved.
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