Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios?

We compare the performance of equal-, value-, and price-weighted portfolios of stocks in the major U.S. equity indices over the last four decades.

Author(s):

Yuliya PlyakhaGoethe

University FrankfurtRaman UppalEDHEC Business School

Grigory Vilkov

Goethe University Frankfurt

We find that the equal-weighted portfolio with monthly rebalancing outperforms the value- and price-weighted portfolios in terms of total mean return, four factor alpha, Sharpe ratio, and certainty-equivalent return, even though the equal-weighted portfolio has greater portfolio risk. The total return of the equal-weighted portfolio exceeds that of the value- and price-weighted because the equal-weighted portfolio has both a higher return for bearing systematic risk and a higher alpha when using the fourfactor model. The nonparametric test of Patton and Timmermann (2010) indicates that the differences in the total return of the equal-weighted portfolio and the value- and price-weighted portfolios is monotonically related to size, price, liquidity and idiosyncratic volatility; the relation with reversal is not monotonic, although the equal-weighted portfolio strongly outperforms the value- and price-weighted portfolios for the deciles with the lowest and the highest reversal characteristic. The higher systematic return of the equal-weighted portfolio arises from its higher exposure to the market, size, and value factors. The higher alpha of the equal-weighted portfolio arises from the monthly rebalancing required to maintain equal weights, which is implicitly a contrarian strategy that exploits reversal; thus, alpha depends only on the rebalancing frequency and not on the choice of initial weights.
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Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfo...
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Type: Working paper
Date: le 23/03/2012
Extra information : For more information, please contact EDHEC Research and Development Department [ research@drd.edhec.edu ]
Research Cluster : Finance

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