To Rebalance or Not to Rebalance: A Statistical Comparison of Terminal Wealth of Fixed-Weight and Buy-and-Hold Portfolios
63 Pages Posted: 1 Mar 2014
Date Written: January 26, 2014
We compare expected value and variance of terminal wealth for two simple but distinctly different portfolio approaches: fixed-weight with regular rebalancing and buy-and-hold with no rebalancing. We carry out statistical analysis under a variety of return assumptions and portfolio settings. For long-only portfolios, we show buy-and-hold approach leads to higher expected terminal wealth but also higher variance of terminal wealth. When there are serial correlations in asset returns, we demonstrate quantitatively that for long-only portfolios mean-reverting returns are relatively more favorable to fixed-weight portfolios whereas trending returns are relatively more favorable to buy-and-hold portfolios. For long-short portfolios, however, the effects of portfolio rebalancing are markedly different from long-only portfolios, mainly due to portfolio leverage. For example, we prove that fixed-weight approach often leads to higher expected value of terminal wealth. But it may also lead to higher variance of terminal wealth although it is not always the case. Furthermore, the effects of serial return correlations on long-short portfolios could be opposite of the effects on long-only portfolios. The overall results suggest that theoretically fixed-weight portfolios with portfolio rebalancing are more likely to have better risk-adjusted terminal wealth than buy-and-hold portfolios.
Keywords: Portfolio Choice, Rebalancing Return
JEL Classification: G11
Suggested Citation: Suggested Citation