Starting from the reward-risk model for portfolio selection introduced in De Giorgi (2005), we derive the reward-risk Capital Asset Pricing Model (CAPM) analogously to the classical mean-variance CAPM. In contrast to the mean-variance model, reward-risk portfolio selection arises from an axiomatic definition of reward and risk measures based on a few basic principles, including consistency with second-order stochastic dominance. With complete markets, we show that at any financial market equilibrium, reward-risk investors' optimal allocations are comonotonic and, therefore, our model reduces to a representative investor model. Moreover, the pricing kernel is an explicitly given, non-increasing function of the market portfolio return, reflecting the representative investor's risk attitude. Finally, an empirical application shows that the reward-risk CAPM captures the cross section of U.S. stock returns better than the mean-variance CAPM does.

, , , , , ,
ERIM Top-Core Articles
Journal of Financial and Quantitative Analysis
Erasmus Research Institute of Management

Post, T., & De Georgi, E. (2008). Second-Order Stochastic Dominance, Reward-Risk Portfolio Selection, and the CAPM. Journal of Financial and Quantitative Analysis, 43(2), 525–546. Retrieved from