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.


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.

Type: Working paper
Date: le 23/03/2012
Research Cluster : Finance

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