Risk Aversion : Mathematical and Economic Perspectives

A necessary condition for a dominance of prospect F over prospect G by all commonly employed investment criteria is E_F (x)≥E_G (x). Because of this requirement, optimal investment rules fail to distinguish between two alternative prospects where in practice one prospect is preferred over the other by all investors—a paradoxical result. We suggest the general almost second-degree stochastic dominance rule (GASSD) that relaxes this necessary condition, resolves the existing paradoxes and distinguishes between mathematically and economically relevant preferences. In the comparison of stocks and bonds for various horizons the GASSD rule does not support the idiom “stocks for the long run