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What Is Stochastic Dominance?

By Jean Marie Asta
Updated: Feb 27, 2024

Stochastic dominance is a concept used to help someone choose between different systems or decisions. It is used in statistics and probability theory to rank the possible decisions a person or business may make and determine which courses of action could produce the best outcomes for those involved. Determining this dominance does not require number-based information. Options are ranked based on simple preferences as well as monetary profitability of taking certain actions.

Principles of stochastic ordering are the basis of stochastic dominance. In this system, variables are ordered in a sequence where the strongest and most useful options are in one group and the weakest and least useful are in another. This system of grouping is useful to data analysts in a number of fields. It can help them predict the actions of their customer base, or help them sort out vast amounts of information pertaining to probability, such as the data used in an insurance company.

There is no concrete method for determining stochastic dominance. The process of determining statewise dominance is one of the more simplified versions that can be used. In the statewise model two systems are compared. If one system offers more benefits and/or fewer drawbacks than the other similar system, then first system would be said to have statewise dominance over the second.

Stochastic dominance is one tool used by decision analysts. It can be contrasted with mean risk analysis. This kind of analysis is more simplified and deals with a concrete formula.

Mean risk analysis seeks to only compare the potential end result, or mean, with the steps that need to be taken to secure this result — the risk. This system is better to use when the analyst is dealing with systems that have variables with easily assigned number values such as cost and amount. Stochastic dominance takes into account more vague principles such as preference and other intangible variables and the models can deal with numbers as well, but do not have a clearly defined formula for researchers to follow when they are using this model.

People use methods of determining stochastic dominance in a variety of scenarios — often without even realizing it. Since it doesn’t solely depend on real numbers, any decisions made that take into account personal preference, along with issues of cost and energy expended can be said to use stochastic dominance. Its use in weighing the risks and benefits of certain actions makes learning the specifics of it useful to any individual who wants a job in data analysis.

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