Variance Covariance Orders and Median Preserving
29 Pages Posted: 22 Apr 2009
Date Written: March 24, 2009
A random variable dominates another random variable with respect to the covariance order if the covariance of any two monotone increasing functions of this variable is smaller. We characterize completely the covariance order, give strong sufficient conditions for it, present a number of examples in concrete economic applications, and provide natural extensions for the multivariate context. In analogy to mean preserving spreads in standard stochastic dominance, we show that the covariance order is intimately linked to a comparison of median preserving spreads of random variables. Moreover, it arises naturally in a variety of important economic questions like, e.g., Hansen-Jagannathan stochastic discount factor bounds, the efficient portfolios implied by semi-variance optimization problems, or the measurement of macroeconomic inequality and dispersion in beliefs.
Keywords: variance, risk, median preserving spread, Hansen-Jagannathan bounds
JEL Classification: G11, C02, D00
Suggested Citation: Suggested Citation