Is it Efficient to Buy the Index? A Worldwide Tour with Stochastic Dominance.

Abstract

The paper develops a necessary condition for stochastic dominance efficiency at any order. We find that equity market indices of seventeen developed and developing countries across the globe are inefficient, nearly always at order three and very often at order two, making them not a suitable investment for a risk-averse and prudent investors. The indices are often dominated by individual industry sub-indices, with consumer goods, services, and utilities performing especially well. Macro factors such as the GDP growth rate, inflation, unemployment, and the current account balance predict future efficiency of the equity market indices, but exhibit the opposite signs for developed and developing markets. Strong values of aggregate economic indicators point to a higher likelihood of the equity market index efficiency for well-balanced economies; but they signal a lower likelihood of efficiency for less balanced economies, which heavily rely on only several key industries.