Ranking Investments Using the Lorenz Curve
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Ranking investments is important for measuring the performance of financial assets over a period of time. The Mean-Variance Model (MV Model) suggests the Reward-to-Variability Index (Sharpe Index) for ranking the performances of investments. However, this model is based on the implicit assumption that the investments’ rate of return is normally distributed. This assumption highlights the importance of a diverse portfolio, but is rarely satisfied. The most accurate method of ranking investments is according to the investor’s preference ratio, described by the stochastic dominance rules (SD Rules). The SD Rules are coherent with the generic properties of the investor’s preference, but their main disadvantage lies in their complex calculations. This paper presents a new method of ranking investments using the Lorenz curve, thus utilizing the investor’s preference ratio ranking and the simplicity of applying the Lorenz curve so as to describe a full order of ranking according to the investor’s behavior.
KeywordsInvestment management Stochastic dominance Lorenz curve Gini Index
JEL ClassificationD81 G11 G32
The author thanks Prof. Haim Shalit for his guidance, and the anonymous reviewers for improving this paper with their helpful comments.
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