Stochastic orders and their applications in financial optimization (Q1809503)

This is a survey paper on the stochastic orders and their applications in the finance optimization. A stochastic order \( X \leq_{ \mathcal F} Y\) of two random variables \(X\) and \(Y\), generated by \(\mathcal F\), a class of functions, means that for any \(f\in \mathcal F\), it holds \(Ef(X)\leq Ef(Y)\). Rich classes of functions give their stochastic order a financial meaning. Quite a few of the commonly used classes are listed in this paper and the meaning of these stochastic orders in finance optimization are exploited. Here \(\mathcal F\) can be the class of increasing functions, the class of concave functions, the joint class of the above two, the completely monotonic functions of order \(n\), the class of functions with increasing likelihood ratio, the class of functions with increasing ratio of the distribution functions. This paper recommends how these stochastic orders describe the finance phenomenon, including the demand problem concerning the condition of when \(X\) is more demanded than \(Y\), the shift effect problem observing the effect of a shift from \(X\) to \(Y\), when a decision is made for maximizing the expected payoff, the rate of return of a risk-free asset in a complete market, the credit rating momentum of firms.