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Testing for central dominance: Method and application
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DOI：10.1016/j.jeconom.2016.07.008.png)
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Abstract
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Central dominance (CD) introduced in Gollier (1995, Journal of Economic Theory) is a risk concept that differs from stochastic dominance (SD) in an important way. In particular, CD implies a deterministic comparative static of a change in decision when risk changes, but SD does not have such an implication. In this paper, we propose the first test of central dominance, which amounts to checking a functional inequality. We derive the asymptotic distribution of a lower bound of the proposed test and suggest a bootstrap procedure to compute the critical values. We also conduct simulations to evaluate the performance of this test. Our empirical study finds clear evidence of CD relations between the S&P 500 index return distributions during 2001-2013 and results in unambiguous implications for investment decisions. (C) 2016 Elsevier B.V. All rights reserved.
Keywords:
Central dominance
Contact set
Functional inequality
Stochastic dominance
Portfolio selection
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