Innovations in Financial Decision-Making: Unveiling Insights Through a Novel Approach to Almost Stochastic Dominance

Abstract

Abstract This comprehensive study investigates the intricate interplay between significance levels in stochastic dominance tests and their impact on asset performance assessment and portfolio construction within the US Energy Sector. Stocks were categorized into Mega Cap, Large Cap, and Mid Cap groups. The analysis spans diverse p-value thresholds, shedding light on the nuances of dominance patterns across First-order Stochastic Dominance (FSD), Second-order Stochastic Dominance (SSD), and Third-order Stochastic Dominance (TSD). According to the results, TSD appears to be the preferred selection criterion across different p-values in portfolio construction. We found also that lower p-values emerge not only as validators of statistical significance but also as potent pre-selection criteria, streamlining portfolio composition and aligning with the under-diversification theory. As the p-value threshold decreases, less assets are found to exhibit stochastic dominance. The observed reduction in the number of selected assets addresses over-diversification concerns, promoting a focused and efficient investment strategy. JEL Codes: G11, G41.