The Cross-Sectional Dispersion of Stock Returns, Alpha and the Information Ratio
Larry R. Gorman
California Polytechnic State University
Steven G. Sapra
Analytic Investors, Inc.; Claremont Graduate University
Robert A. Weigand
Washburn University School of Business
January 21, 2010
Journal of Investing, Forthcoming
Both the cross-sectional dispersion of U.S. stock returns and the VIX provide forecasts of alpha dispersion across high- and low-performing portfolios of stocks that are statistically and economically significant. These findings suggest that absolute return investors can use cross-sectional dispersion and time-series volatility as signals to improve the tactical timing of their alpha-focused strategies. Because active risk increases by a greater amount than alpha, however, high return dispersion/high VIX periods are followed by slightly lower information ratio dispersion. Therefore, relative return investors who keep score in an information ratio framework are unlikely to find return dispersion useful as a signal regarding when to increase or decrease the activeness of their portfolio strategies.
Number of Pages in PDF File: 37
Keywords: Alpha, Information Ratio, Cross-Sectional Dispersion, Volatility, VIX
JEL Classification: G11, G17
Date posted: August 6, 2009 ; Last revised: February 9, 2010
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