The Sources of Portfolio Returns: Underlying Stock Returns and the Excess Growth Rate

42 Pages Posted: 5 Apr 2011 Last revised: 25 Aug 2011

Jason T. Greene

The University of Alabama in Huntsville

David A. Rakowski

University of Texas at Arlington

Date Written: August 22, 2011

Abstract

This paper decomposes portfolio returns into the underlying sources arising from the constituent stocks’ growth rates, as well as their variances and covariances. We employ this method to show that the difference between large and small stock portfolio returns is driven by a portfolio “excess growth rate” that is induced by the higher volatility of small stocks’ returns and not by the average growth rate of small stocks. Therefore, the “size effect” is not a small firm effect, but a small firm portfolio effect driven by the excess growth rate of the portfolios. In contrast, portfolios of high book-to-market stocks outperform due to higher average levels of growth by the constituent stocks and not due to their variance-covariance structure. Our results demonstrate the importance of considering the sources of portfolio performance as possibly distinct from the performance of the portfolio’s underlying stocks when designing and interpreting studies of portfolio performance, corporate events, or the cross-section of stock returns.

Keywords: Portfolio Returns, Portfolio Growth Rates, Size Effect, Long-Term Stock Returns

JEL Classification: G11, G12, G14

Suggested Citation

Greene, Jason T. and Rakowski, David A., The Sources of Portfolio Returns: Underlying Stock Returns and the Excess Growth Rate (August 22, 2011). Available at SSRN: https://ssrn.com/abstract=1802591 or http://dx.doi.org/10.2139/ssrn.1802591

Jason T. Greene (Contact Author)

The University of Alabama in Huntsville ( email )

301 Sparkman Drive
Huntsville, AL 35899
United States
256-824-4424 (Phone)

HOME PAGE: http://www.uah.edu/cba

David A. Rakowski

University of Texas at Arlington ( email )

Box 19449 UTA
Arlington, TX 76019
United States

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