Mean-Variance-Skewness Portfolio Performance Gauging: A General Shortage Function and Dual Approach

This paper proposes a nonparametric efficiency measurement approach for the static portfolio selection problem in mean-variance-skewness space. A shortage function is defined that looks for possible increases in return and skewness and decreases in variance. Global optimality is guaranteed for the resulting optimal portfolios. We also establish a link to a proper indirect mean-variance-skewness utility function. For computational reasons, the optimal portfolios resulting from this dual approach are only locally optimal. This framework makes it possible to differentiate between portfolio efficiency and allocative efficiency, and a convexity efficiency component related to the difference between the primal, non-convex approach and the dual, convex approach. Furthermore, in principle, information can be retrieved about the revealed risk aversion and prudence of investors. An empirical section on a small sample of assets serves as an illustration. A revisited version of this paper was published in the January 2007 issue of Management Science.