Stochastic Dominance with Riskless Assets

Abstract

Investment decision making under conditions of uncertainty, and in particular portfolio selection, is carried out mainly in the Mean-Variance framework which has been developed by Markowitz [29], [30] and Tobin [42]. By assuming the lending and borrowing of money at a given riskless interest rate, Sharpe [39], [40], Lintner [27], [28], Mossin [34], and others derived and extended the Capital Asset Pricing Model, under which an equilibrium price of each risky asset is determined. However, though the mean variance rule is quite convenient to apply, its limitations are well known, i.e., one must assume either normal probability distributions with risk aversion or quadratic utility functions.