Stochastic Dominance Tests Research Articles

Inequality of opportunities in health in France: a first pass

This article analyses the role played by childhood circumstances, especially social and family background in explaining health status among older adults. We explore the hypothesis of an intergenerational transmission of health inequalities using the French part of SHARE. As the impact of both social background and parents' health on health status in adulthood represents circumstances independent of individual responsibility, this study allows us testing the existence in France of inequalities of opportunity in health related to family and social background. Empirically, our study relies on tests of stochastic dominance at first order and multivariate regressions, supplemented by a counterfactual analysis to evaluate the long-lasting impact of childhood conditions on inequality in health. Allocating the best circumstances in both parents' socioeconomic status and parents' health reduces inequality in health by an impressive 57% using the Gini coefficient. The mother's social status has a direct effect on the health of her offspring. By contrast, the effect on descendant's health from their father's social status is indirect only, which goes through the descendant's social status as an adult. There is also a strong effect of the father vital status on health in adulthood, revealing a selection effect.

Testing for Mobility Dominance

This paper proposes tests for stochastic dominance in mobility based on the empirical likelihood ratio. Two views of mobility are considered, either based on measures of absolute mobility or on transition matrices. First-order and second-order dominance conditions in mobility are first derived, followed by the derivation of statistical inferences techniques to test a null hypothesis of non dominance against an alternative of mobility dominance. An empirical analysis, based on the US Panel Study of Income Dynamics (PSID), is performed by comparing four income mobility periods ranging from 1970 to 1990.

Empirical Test of the Efficiency of UK Covered Warrants Market: Stochastic Dominance and Likelihood Ratio Test Approach

This paper first examines the efficiency of the UK covered warrants market by adopting a stochastic dominance (SD) approach to examine market efficiency. Our empirical analyses reveal that neither covered warrants nor the underlying shares stochastically dominate each other, which implies that the UK covered warrants market is efficient. To complement the SD results, the likelihood ratio (LR) test statistic is also employed to evaluate market efficiency, which also offers consistent results. The empirical evidence serves as a reference for market participants who are interested in covered warrants and also contributes to the growing body of academic knowledge on this new financial instrument.

Gender Poverty in Tunisia

The paper investigates the association between gender and poverty in Tunisia based upon an empirical analysis of 1990 and 2000 household surveys. It also tests whether or not there is a widespread feminization of poverty. To achieve these goals, the paper suggests a theoretically sound method to compute expenditure-based incidence of poverty and tests for differences in the headcount ratio between female- and male-headed households for a given period and whether or not this difference is increasing over time. Stochastic dominance tests are also performed to avoid arbitrary choices of poverty lines and indices. The results suggest that although female-headed households are subject to unequal treatment in the labor market, they are not poorer than their male counterparts, as they live with more active persons. However, as we increase the poverty line, the poverty difference between female- and male-headed households rises to the detriment of female-headed households and becomes statistically significant. However, what is more disquieting is that this difference increases over time due to the fall in both the level of and the returns to female labor endowment.

Stochastic Dominance and Investors’ Behavior towards Risk: The Hong Kong Stocks and Futures Markets

This paper applies stochastic dominance (SD) tests to examine the dominance relationships between the futures and spot markets in Hong Kong. We also analyze the preferences for the risk averters, risk seekers, prospect investors, and Markowitz investors with further in dept of their positive and negative domains in these markets. We find that for the risk averters, spot dominates futures while for the risk seekers, futures dominate spot. This implies that the risk averters prefer to buy indexed stocks, while risk seekers are attracted to long index futures to maximize their expected utilities, but not necessary their wealth. We also conclude that in general, the prospect investors prefer spot in the positive domain and prefer futures in the negative domain while the Markowitz investors prefer spot in the negative domain and prefer futures in the positive domain.

Are Options on Index Futures Profitable for Risk Averse Investors? Empirical Evidence

American options on the S&P 500 index futures that violate the stochastic dominance bounds of Constantinides and Perrakis (2007) from 1983 to 2006 are identified as potentially profitable trades. Call bid prices more frequently violate their upper bound than put bid prices do, while violations of the lower bounds by ask prices are infrequent. In out of sample tests of stochastic dominance, the writing of options that violate the upper bound increases the expected utility of any risk averse investor holding the market and cash, net of transaction costs and bid ask spreads. The results are economically significant and robust.

Testing for Restricted Stochastic Dominance: Some Further Results

Extensions are presented to the results of Davidson and Duclos (2007), whereby the null
 hypothesis of restricted stochastic non dominance can be tested by both asymptotic and
 bootstrap tests, the latter having considerably better properties as regards both size and
 power. In this paper, the methodology is extended to tests of higher-order stochastic dominance.
 It is seen that, unlike the first-order case, a numerical nonlinear optimisation problem
 has to be solved in order to construct the bootstrap DGP. Conditions are provided for a
 solution to exist for this problem, and efficient numerical algorithms are laid out. The empirically
 important case in which the samples to be compared are correlated is also treated,
 both for first-order and for higher-order dominance. For all of these extensions, the bootstrap
 algorithm is presented. Simulation experiments show that the bootstrap tests perform
 considerably better than asymptotic tests, and yield reliable inference in moderately sized
 samples.

Marine Parks and Household Poverty in Tanzania: A Baseline Analysis

This paper offers a baseline data for future assessment of the extent to which Marine Parks improve households’ welfare and reduce poverty in the Tanzanian Coastal area. Household Budget Survey Data was collected from 24 villages along the coast of Tanzania Mainland and Zanzibar. Axiomatically preferred poverty indices are used in this paper to assess relative poverty between villages currently in the Marine Parks and villages that are outside the Marine Parks. The analysis is buttressed by stochastic dominance tests to ensure that the results are robust to any reasonable alteration of poverty line. The paper finds widespread poverty but no notable difference in poverty between villages in the Marine Park Areas and villages outside the Marine Parks. This is important baseline information for future analysis of the impact of Marine Parks on households’ welfare.

Semi-nonparametric test of second degree stochastic dominance with respect to a function

In an expected utility framework, assuming a decision maker operates under utility k ( ⋅ | θ ) , for two risky alternatives X and Y with respective distribution functions F and G , alternative X is said to dominate alternative Y with respect to k ( ⋅ | θ ) if ∫ − ∞ y [ F ( t ) − G ( t ) ] d k ( t | θ ) ≤ 0 for all y . Utilizing the empirical distribution functions of F and G , a statistical test is presented to test the null hypothesis of indifference between X and Y given k ( ⋅ | θ ) against the hypothesis that X dominates Y with respect to k ( ⋅ | θ ) . This is a large sample testing application of stochastic dominance with respect to a function. The asymptotic distribution of the test statistic associated with the null hypothesis given a sub-set of the utility function parameter space is developed. Based on large sample rejection regions, the hypothesis of preference of one alternative over another is demonstrated with an empirical example.

An improved bootstrap test of stochastic dominance

We propose a new method of testing stochastic dominance that improves on existing tests based on the standard bootstrap or subsampling. The method admits prospects involving infinite as well as finite dimensional unknown parameters, so that the variables are allowed to be residuals from nonparametric and semiparametric models. The proposed bootstrap tests have asymptotic sizes that are less than or equal to the nominal level uniformly over probabilities in the null hypothesis under regularity conditions. This paper also characterizes the set of probabilities so that the asymptotic size is exactly equal to the nominal level uniformly. As our simulation results show, these characteristics of our tests lead to an improved power property in general. The improvement stems from the design of the bootstrap test whose limiting behavior mimics the discontinuity of the original test’s limiting distribution.

Firm Productivity and Foreign Direct Investment into Non‐core Activities*

As foreign direct investment (FDI) often originates from multinational enterprises (MNEs) with non‐core activities and not single‐product firms, as MNE theory typically suggests, we hypothesize that such firms are more productive than MNEs without non‐core activities as well as non‐MNE firms. We test this hypothesis using Kolmogorov–Smirnov stochastic dominance Tests and Japanese firm‐level productivity and FDI data for the period 1985–2001. We find that both manufacturing and service multinational firms with non‐core foreign investments stochastically dominate firms without non‐core activities. We also find cost‐complementarities between certain core and non‐core FDI activities that span both manufacturing and service affiliates.

Inequality of opportunity in health: evidence from a UK cohort study

This paper proposes an empirical implementation of the concept of inequality of opportunity in health and applies this to data from the UK National Child Development Study. Drawing on the distinction between circumstance and effort variables in John Roemer's work on equality of opportunity, circumstances are proxied by parental socio-economic status and childhood health; effort is proxied by health-related lifestyles and educational attainment. Stochastic dominance tests are used to detect inequality of opportunity in the conditional distributions of self-assessed health in adulthood. Two alternative approaches are used to measure inequality of opportunity. Econometric models are estimated to illuminate and quantify the triangular relationship between circumstances, effort and health. The results indicate the existence of a considerable and persistent inequality of opportunity in health. Circumstances affect health in adulthood both directly and through effort factors such as educational attainment. This indicates that, while the influence of some unjust circumstances can only be tackled during childhood, the implementation of complementary educational policies may be of paramount importance.

Measuring the Volatility in U.S. Treasury Benchmarks and Debt Instruments

As U.S. Treasury securities carry the full faith and credit of the U.S. government, they are free of default risk. Thus, their yields are risk-free rates of return, which allows the most recently issued U.S. Treasury securities to be used as a benchmark to price other fixed-income instruments. This article analyzes the time series properties of interest rates on U.S. Treasury benchmarks and related debt instruments by modelling the conditional mean and conditional volatility for weekly yields on 12 Treasury Bills and other debt instruments for the period January 8, 1982 to August 20, 2004. The conditional correlations between all pairs of debt instruments are also calculated. These estimates are of interest as they enable an assessment of the implications of modelling conditional volatility on forecasting performance. The estimated conditional correlation coefficients indicate whether there is specialization, diversification, or independence in the debt instrument shocks. Constant conditional correlation estimates of the standardized shocks indicate that the shocks to the first differences in the debt instrument yields are generally high and always positively correlated. In general, the primary purpose in holding a portfolio of Treasury Bills and other debt instruments should be to specialize on instruments that provide the largest returns. Tests for Stochastic Dominance are generally consistent with these findings, but find somewhat surprising rankings between debt instruments, with implications for portfolio composition. Thirty year treasuries, Aaa bonds, and mortgages tend to dominate the other instruments, at least to the second order.

Speculative trading and stock returns: A stochastic dominance analysis of the Chinese A-share market

The pricing of A-shares in China has long puzzled financial economists. This paper applies recent tests of stochastic dominance (SD) to examine whether differences in the return distributions of A- and B-shares in China are consistent with market efficiency. As SD is nonparametric, market efficiency can be examined without the joint test problem arising from misspecifications in the asset pricing benchmark. Our results show A-shares have second-order dominated B-shares from 1996 to 2005. This dominance was most significant during the market segmentation period, but has continued, albeit to a lesser extent even after the B-share market was opened to local investors in 2001. Our results are robust to using residual returns from an international asset pricing model instead of raw returns. We conclude that the superior performance of A-shares cannot be attributed to risk. The results are more likely due to a return bias caused by intense speculation among retail individuals under limited arbitrage.

Futures versus Stocks: A Stochastic Dominance Study in Malaysian Markets

This paper applies stochastic dominance (SD) tests to examine the dominance relationship between the futures and spot markets in Malaysia, the preferences for the risk-averse and risk-seekers in these markets, the existence of arbitrage opportunities, and whether the markets are efficient and rational. Our results show that there is no arbitrage opportunity in the Malaysian markets and that the Malaysian stock and futures markets can be considered efficient and rational. We find that the spot dominates the futures market on the downside risk, whereas futures dominate spot on the upside profits. In addition, we find that for the risk-averse, spot dominates futures under second-order SD (SSD), while for risk-seekers, futures dominate spot under SSD. This implies that the risk-averse prefer to buy indexed stocks, while risk-seekers are attracted to long index futures to maximize their expected utilities, but not their wealth. Based on our findings, the SSD relationship becomes stronger in the post-Mahathir sub-period.

An Improved Bootstrap Test of Stochastic Dominance

We propose a new method of testing stochastic dominance that improves on existing tests based on the standard bootstrap or subsampling. The method admits prospects involving infinite as well as finite dimensional unknown parameters, so that the variables are allowed to be residuals from nonparametric and semiparametric models. The proposed bootstrap tests have asymptotic sizes that are less than or equal to the nominal level uniformly over probabilities in the null hypothesis under regularity conditions. This paper also characterizes the set of probabilities that the asymptotic size is exactly equal to the nominal level uniformly. As our simulation results show, these characteristics of our tests lead to an improved power property in general. The improvement stems from the design of the bootstrap test whose limiting behavior mimics the discontinuity of the original test's limiting distribution.

Legislative Pay and Legislator Quality

AbstractThis study extends previous work by Mixon and Wilkinson (1999, Public Finance Review 27: 418–433) and Palia (2000, RAND Journal of Economics 31: 165–179) suggesting that formal human capital attainment is lower in political and managerial roles wherein expected compensation is less. The present study constructs a cumulative probability distribution function for years of education attained for both branches of the 109th US Congress and finds that the distribution of years of education attainment in the US Senate second‐order dominates that in the US House due to differences in the expected compensation levels favoring the former congressional branch. The stochastic dominance test results are supported by findings of significant differences in education attainment (favoring senators) at different quantiles of the joint education attainment distribution. Finally, goodness‐of‐fit tests also indicate that the distribution of education attainment quality in the US Senate, as measured by various academic institution quality indicators, is significantly different from that in the US House, again owing to the differences in expected compensation.

The unsung impact of currency risk on the performance of international real property investment

The paper revisits the currency risk debate to ascertain the statistical significance of currency risk on the return of international real property investment, especially in a period of increased exchange rate volatility. After statistical analyses of the returns of a portfolio of office investments in seven Asia Pacific cities over the 1986 to 2007 period, it was found that currency risk had a statistically significant positive impact on the performance of the portfolio of office investments. This is confirmed by the results of stochastic dominance test. If the results of this study are verified by subsequent studies, and the past reliably presages the future, they would imply that investors holding portfolios of real property investments in the sample markets might not need to be unduly concerned with currency risk.

Industrial Real Estate Investment: Does the Contrarian Strategy Work?

The superiority of the contrarian investment strategy, though well attested to in the finance literature, has received scant attention, if any, in the real estate literature. This study uses empirical industrial real estate investment return data from 1985Q1 to 2005Q3 for the US, and some Asia Pacific cities in order to ascertain the relative superiority of “value” and “growth” industrial real estate investments. The results show that “value” industrial property investment outperformed “growth” industrial property investment in all the holding periods under consideration. Furthermore the industrial property investments exhibit return reversal. This implies that the superiority of the contrarian strategy is sustainable. The results of stochastic dominance tests validate the relative superiority of “value” over “growth” industrial property investment. This implies that fund managers who traditionally have been favoring prime (i.e. growth) industrial property investment may have to reconsider their investment strategy if they want to maximize their return.

Firm heterogeneity, foreign market entry mode and ownership choice

We study the relationship between firm productivity, foreign market entry mode and affiliate ownership choice using Kolmogorov–Smirnov stochastic dominance tests on Japanese firm-level productivity and horizontal FDI data into 20 OECD countries during the period 1985–2001. We devote particular attention to different types of joint ventures to find that affiliate ownership increases with the parent firm's TFP.