Testing Conditional Stochastic Dominance at Target Points

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This paper introduces a novel test for conditional stochastic dominance (CSD) at specific values of the conditioning covariates, referred to as target points. The test is relevant for analyzing income inequality, evaluating treatment effects, and studying discrimination. We propose a Kolmogorov-Smirnov-type test statistic that utilizes induced order statistics from independent samples. Notably, the test features a data-independent critical value, eliminating the need for resampling techniques such as the bootstrap. Our approach avoids kernel smoothing and parametric assumptions, instead relying on a tuning parameter to select relevant observations. We establish the asymptotic properties of our test, showing that the induced order statistics converge to independent draws from the true conditional distributions and that the test is asymptotically of level alpha under weak regularity conditions. While our results apply to both continuous and discrete data, in the discrete case, the critical value only provides a valid upper bound. To address this, we propose a refined critical value that significantly enhances power, requiring only knowledge of the support size of the distributions. Additionally, we analyze the test's behavior in the limit experiment, demonstrating that it reduces to a problem analogous to testing unconditional stochastic dominance in finite samples. This framework allows us to prove the validity of permutation-based tests for stochastic dominance when the random variables are continuous. Monte Carlo simulations confirm the strong finite-sample performance of our method.