Thierry Post

Empirical Tests for Stochastic Dominance Efficiency

We derive empirical tests for the stochastic dominance efficiency of a given portfolio with respect to all possible portfolios constructed from a set of assets. The tests can be computed using straightforward linear programming. Bootstrapping techniques and asymptotic distribution theory can approximate the sampling properties of the test results and allow for statistical inference. Our results could provide a stimulus to the further proliferation of stochastic dominance for the problem of portfolio selection and evaluation. Using our tests, the Fama and French market portfolio is significantly inefficient relative to benchmark portfolios formed on market capitalization and book-to-market equity ratio.

Optimal Portfolio Choice under Loss Aversion

This paper analyzes the optimal investment strategy for loss averse investors, assuming a complete market and general Ito processes for the asset prices. The loss-averse investor follows a partial portfolio insurance strategy. When the investors planning horizon is short (less than 5 years), he or she considerably reduces the initial portfolio weight of stocks compared to an investor with smooth power utility. The empirical section of the paper estimates the level of loss aversion implied by historical U.S. stock market data, using a representative agent model. We find that loss aversion and risk aversion cannot be disentangled empirically.

Performance benchmarking using interactive data envelopment analysis

This paper presents a procedure for performance benchmarking, that extends the performance measurement technique Data Envelopment Analysis (DEA), to incorporate the interactive decision procedure Interactive Multiple Goal Programming (IMGP). The resulting procedure is called Interactive Data Envelopment Analysis (IDEA). It is a decision support tool that helps decision makers to select performance benchmarks that are both feasible and desirable, and to identify benchmark partners that may be helpful in uncovering ways for achieving the selected performance standards. The IDEA concepts and characteristics are illustrated by means of an example IDEA assessment, using previously reported operating performance data of UK university departments.

A quasi-concave DEA model with an application for bank branch performance evaluation

Abstract In this paper, we present a data envelopment analysis (DEA) model that replaces the standard DEA assumption of concavity for the production frontier with the less restrictive microeconomic assumption of quasi-concavity. The resulting quasi-concave model circumvents the potential specification error that comes with CCR and BCC models, if the production technology is non-concave, e.g. because of increasing marginal productivity. In addition, the model reduces the potential finite sample error associated with FDH models in small and medium-sized samples. A real-life application for the branch network of a large Dutch bank illustrates the operation of the quasi-concave model and its potential for improving performance evaluation.

What Is the Economic Meaning of FDH? A Reply to Thrall

In a recent issue of the Journal of Productivity Analysis, Thrall (1999) called for abandoning the Free Disposable Hull (FDH, Deprins et al. (1984)) approximation of production possibilities as economically meaningless in comparison to the Convex Monotone Hull (CMH; Banker et al. (1984)) approximation. This strong conclusion was solely based on Thralls Principal Theorem, which essentially demonstrates that FDH can give a technically efficient classification to output-input vectors that are inefficient in terms of profit maximisation, i.e. at all non-negative price vectors there exists an alternative output-input vector that yields higher profit. In this short communication, we argue that the economic meaning of the competing empirical production sets cannot be inferred from this theorem. Specifically, we demonstrate that both empirical production sets are economically equally meaningful under the economic conditions that underlie Thralls theorem. In addition, we demonstrate that FDH can be economically more meaningful than CMH under non-trivial alternative economic conditions.

Multivariate Tests for Stochastic Dominance Efficiency of a Given Portfolio

We develop empirical tests for stochastic dominance efficiency of a given investment portfolio relative to all possible portfolios formed from a given set of assets. Our tests use multivariate statistics, which result in superior statistical power properties compared to existing stochastic dominance efficiency tests and increase the comparability with existing mean-variance efficiency tests. Using our tests, we demonstrate that the mean-variance inefficiency of the CRSP all-share index relative to beta-sorted portfolios can be explained by tail risk not captured by variance.

Methodological Advances in DEA: A survey and an application for the Dutch electricity sector

We survey the methodological advances in DEA over the last 25 years and discuss the necessary conditions for a sound empirical application. We hope this survey will contribute to the further dissemination of DEA, the knowledge of its relative strengths and weaknesses, and the tools currently available for exploiting its full potential. Our main points are illustrated by the case of the DEA study used by the regulatory office of the Dutch electricity sector (Dienst Toezicht Elektriciteitswet; Dte) for setting price caps.

General linear formulations of stochastic dominance criteria

We develop and implement linear formulations of general Nth order stochastic dominance criteria for discrete probability distributions. Our approach is based on a piece-wise polynomial representation of utility and its derivatives and can be implemented by solving a relatively small system of linear inequalities. This approach allows for comparing a given prospect with a discrete set of alternative prospects as well as for comparison with a polyhedral set of linear combinations of prospects. We also derive a linear dual formulation in terms of lower partial moments and co-lower partial moments. An empirical application to historical stock market data suggests that the passive stock market portfolio is highly inefficient relative to actively managed portfolios for all investment horizons and for nearly all investors. The results also illustrate that the mean–variance rule and second-order stochastic dominance rule may not detect market portfolio inefficiency because of non-trivial violations of non-satiation and prudence.

FDH Directional Distance Functions with an Application to European Commercial Banks

Weextend Free Disposable Hull (FDH) efficiency analysis towardsthe general directional distance function framework. The profitinterpretation of directional distance functions is extendedto the non-convex FDH technologies. In addition, we derive anefficient enumerative algorithm for computing distance measuresin Free Disposable Hull (FDH) technologies, which applies tothe entire (infinitely large) family of directional distancefunctions. A simple numerical example and an application to Europeancommercial banks illustrate the algorithm.

On the performance of emerging market equity mutual funds

We document persistence in the performance of emerging market equity funds and find some notable differences compared to US funds. First, the contribution of winner funds to the return spread between winner and losers is substantially larger for emerging market funds. Second, only a small portion of the return spread between winners and losers can be attributed to momentum effects in emerging markets. Third, while US winner funds have been documented to underperform benchmark factors correcting for size, value and momentum effects by the magnitude of their expenses, winner funds in emerging markets generate returns that are sufficiently large enough to cover their expenses. Overall, our findings suggest that emerging market funds generally display better performance than US funds.