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Stochastic Dominance With a Riskless Asset: An Imperfect Market

Published online by Cambridge University Press:  06 April 2009

Yoram Kroll  and
Haim Levy
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Extract

The assumption that investors can borrow and lend at a riskless interest rate reduces the Mean-Variance (M-V) efficient set to only one optimal unlevered portfolio. However, once we realize that the market is generally imperfect and that the borrowing rate is higher than the lending rate, we can no longer use the mean-variance Separation Theorem. Instead, a number of unlevered portfolios must be included in the efficient set, while the optimal unlevered portfolio is selected on the basis of the investor's preference. The size of the efficient set of unlevered portfolios is a function of the type of empirical data used and of the disparity between the borrowing and lending interest rates.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 14 , Issue 2 , June 1979 , pp. 179 - 204
Copyright
Copyright © School of Business Administration, University of Washington 1979

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