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Almost Stochastic Dominance: A Penchant for Risk

This paper shows that the Almost Stochastic Dominance (ASD) decision rule overlooks the effect of leverage on the variance of portfolio returns. If a portfolio dominates another by ASD then that portfolio bought with any amount of leverage will also be dominant by ASD. Therefore, there is no limit to the risk that a portfolio may have and still be dominant. The effect of leverage on returns is particularly important as new Exchange Traded Funds offer returns on an index which are enhanced by leverage. ASD cannot distinguish between index returns which are and are not enhanced by leverage, and therefore the decision rule could lead financial planners using ASD to recommend far too risky investments.