An Application of Stochastic Dominance with Truncated Normal Disribution on LQ45 Index

Abstract

Return is the profit obtained by investors from the capital invested in a company. The movement of stock prices in an exchange affect the condition of stock returns. Stochastic dominance with truncated normal distribution is an analysis method of stock dominance with parametric approach where the stock returns is bounded between two values. The purpose of this research is to obtain the optimum stocks listed in the LQ45 index using stochastic dominance with truncated normal distribution. The assumption of a truncated normal distribution is derived from the normal distribution of monthly stock returns that symmetrically truncated on two sides. The dominance of stocks then obtained by comparing the truncated cumulative distribution function of returns based on first order stochastic dominance (FSD) and second order stochastic dominance (SSD). Based on the analysis, it can be concluded that there are 17 stock combinations that dominated by FSD and 14 stock combinations that dominated by SSD.