Characterizing Efficient Portfolios

Abstract

We provide here a necessary and sufficient operational condition for determining whether a given portfolio is efficient in the sense of second-degree stochastic Dominance (SSD). This condition also enables one to find a direction for improving on an inefficient portfolio, in the sense that all risk averse investors would weakly prefer that change in the portfolio composition. This condition can be applied among others to resolve questions that have long been posed in the literature, concerning on whether the portfolios that are promoted by portfolio managers are in fact efficient in the above sense.

Keywords: Stochastic Dominance, Optimal Portfolio, Efficient Portfolio

JEL Classification: G11