Review of Quantitative Finance and Accounting

, Volume 12, Issue 2, pp 103–113 | Cite as

A Performance Comparison Between Cross-Sectional Stochastic Dominance and Traditional Event Study Methodologies

  • Glen A. LarsenJr.
  • Bruce G. Resnick


In this study, the performance of cross-sectional stochastic dominance (SD), first proposed by Falk and Levy (FL) (1989), is compared with three traditional event study methodologies: the Mean Adjusted model, the Market Adjusted model, and the Market and Risk Adjusted Returns model. The comparison technique we use is a simulations approach similar to that of Brown and Warner (BW) (1980). BW show that the Mean Adjusted and Market Adjusted Returns models perform as well as the more sophisticated Market and Risk Adjusted Returns model. FL, however, provide a very compelling argument against the three traditional event study methodologies. The problem, they note, is not the theoretical need for risk adjustment; it is the definition and measurement of risk. FL assert that the observed abnormal returns (or lack thereof) may be due to omitted variables, a market proxy effect, or other specification errors in implementing the traditional event study methodologies.

The present research finds that SD analysis without the bootstrap method for statistical testing is not very useful at any level of abnormal return. However, when the bootstrap method of statistical testing is employed, SD is found to perform as well as, and sometimes better than, the three traditional models in detecting simulated abnormal performance at all test levels. The results are consistent with FL\'s assertion that the improved performance may result from the SD methodology being free from the specification errors inherent in the three traditional event study models.

Stochastic dominance abnormal returns portfolio performance 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Brown, S. J. and J. B. Warner, "Measuring Security Price Performance." Journal of Financial Economics 8, 205–258, (1980).Google Scholar
  2. Efron, B., "Bootstrap Method: Another Look at the Jackknife." Annals of Statistics 7, 1–26, (1979).Google Scholar
  3. Falk, H. and H. Levy, "Market Reaction to Quarterly Earnings Announcements: A Stochastic Dominance Based Test of Market Efficiency." Management Science 35, 425–446, (1989).Google Scholar
  4. Hadar, J. and W. R. Russell, "Rules for Ordering Uncertain Prospects." American Economic Review 59, 25–34, (1969).Google Scholar
  5. Hanoch, G. and H. Levy, "The Efficiency Analysis of Choice Involving Risk." Review of Economic Studies 36, 335–346, (1969).Google Scholar
  6. Larsen, G. A. and B. G. Resnick, "Bootstrapping a Distance Test for Stochastic Dominance Analysis." Review of Quantitative Finance and Accounting 3, 61–69, (1993).Google Scholar
  7. Larsen, G. A. and B. G. Resnick, "Refining the Bootstrap Method of Stochastic Dominance Analysis: The Case of the January Effect." Review of Quantitative Finance and Accounting forthcoming, (1996).Google Scholar
  8. Levy, H. and Y. Kroll, "Efficiency Analysis with Borrowing and Lending Criteria and Their Effectiveness." Review of Economics and Statistics 2, 13–37, (1979).Google Scholar
  9. Lintner, J., "The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets." The Review of Economics and Statistics 47, 13–37, (1965).Google Scholar
  10. Quirk, J. P. and R. Saposnik, "Admissibility and Measurable Utility Functions." Review of Economic Studies 9, 140–146, (1962).Google Scholar
  11. Sharpe, W. F., "Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk." Journal of Finance 19, 425–442, (1964).Google Scholar
  12. Whitmore, G. A., "Third Degree Stochastic Dominance." American Economic Review 60, 457–459, (1970).Google Scholar
  13. Whitmore, G. A. "Statistical Tests for Stochastic Dominance." in G. A. Whitmore and M. C. Findlay, eds., Stochastic Dominance: An Approach to Decision Making Under Risk (Lexington Book, Lexington, MA), (1978).Google Scholar

Copyright information

© 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands. 1999

Authors and Affiliations

  • Glen A. LarsenJr.
    • 1
  • Bruce G. Resnick
    • 2
  1. 1.Department of FinanceKelley School of Business, Indiana UniversityIndianapolis
  2. 2.Babcock Graduate School of Management, Wake Forest UniversityWinston-Salem

Personalised recommendations