Omega-optimized portfolios: applying stochastic dominance criterion for the selection of the threshold return

Renaldas Vilkancas

Abstract


Purpose of the article: While using asymmetric risk-return measures an important role is played by selection of the investor‘s required or threshold rate of return. The scientific literature usually states that every investor should define this rate according to their degree of risk aversion. In this paper, it is attempted to look at the problem from a different perspective – empirical research is aimed at determining the influence of the threshold rate of return on the portfolio characteristics.
Methodology/methods: In order to determine the threshold rate of return a stochastic dominance criterion was used. The results are verified using the commonly applied method of backtesting.
Scientific aim: The aim of this paper is to propose a method allowing selecting the threshold rate of return reliably and objectively.
Findings: Empirical research confirms that stochastic dominance criteria can be successfully applied to determine the rate of return preferred by the investor.
Conclusions: A risk-free investment rate or simply a zero rate of return commonly used in practice is often justified neither by theoretical nor empirical studies. This work suggests determining the threshold rate of return by applying the stochastic dominance criterion.

Keywords


Omega function, portfolio optimization, threshold return, stochastic dominance, differential evolution (DE);

JEL Classification


D81, G11, C61

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Online: 2016-05-30


DOI: http://dx.doi.org/10.13164/trends.2016.25.56