The Cross-Sectional Dispersion of Stock Returns, Alpha and the Information Ratio

Abstract:     
We find that the cross-sectional dispersion of U.S. stock returns provides economically significant forecasts of alpha dispersion across high- and low-performing portfolios of stocks over 3-month and 1-year horizons. Conventional measures of time-series volatility provide similar signals regarding alpha dispersion, but neither return dispersion nor volatility identify future dispersion in the information ratio. These results suggest that absolute return investors can use both cross-sectional dispersion and time-series volatility as signals to improve the tactical timing of their alpha-focused strategies, but relative return investors, keeping score in an information ratio framework, are unlikely to find dispersion or volatility valuable as signals of when to increase or decrease the activeness of their strategies.

Keywords: Alpha, Information Ratio, Cross-Sectional Dispersion, Volatility, VIX

JEL Classifications: G11, G17

Working Paper Series