New development on the third-order stochastic dominance for risk-averse and risk-seeking investors with application in risk management

Raymond H. CHAN, Ephraim CLARK, Xu GUO, Wing Keung WONG*

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)peer-review

15 Citations (Scopus)

Abstract

This paper develops new financial theory to link the third-order stochastic dominance (TSD) for risk-averse and risk-seeking investors and provide illustration of application in risk management. We present some interesting new properties of TSD for risk-averse and risk-seeking investors. We show that the means of the assets being compared should be included in the definition of TSD for both investor types. We also derive the conditions on the variance order of two assets with equal means for both investor types and extend the second-order SD reversal result of Levy and Levy (Manag Sci 48(10):1334–1349, 2002) to TSD. We apply our results to analyze the investment behaviors on traditional stocks and internet stocks for both risk averters and risk seekers.

Original languageEnglish
Pages (from-to)108-132
Number of pages25
JournalRisk Management
Volume22
Issue number2
Early online date16 Nov 2019
DOIs
Publication statusPublished - Jun 2020
Externally publishedYes

Bibliographical note

Publisher Copyright:
© 2019, Springer Nature Limited.

Keywords

  • Expected-utility maximization
  • Investment behaviors
  • Risk aversion
  • Risk-seeking
  • Third-order stochastic dominance

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