Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios?

54 Pages Posted: 29 Jan 2016 Last revised: 16 Sep 2017

See all articles by Yuliya Plyakha

Yuliya Plyakha

Universite du Luxembourg - School of Finance

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

Grigory Vilkov

Frankfurt School of Finance & Management

Date Written: March 1, 2012

Abstract

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. 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 measured using the four-factor model. The nonparametric monotonicity relation test 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 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 a contrarian strategy that exploits reversal and idiosyncratic volatility of the stock returns; thus, alpha depends only on the monthly rebalancing and not on the choice of initial weights.

Keywords: stock index, systematic risk, idiosyncratic risk, factor models, contrarian, trend following

JEL Classification: G11, G12

Suggested Citation

Plyakha, Yuliya and Uppal, Raman and Vilkov, Grigory, Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios? (March 1, 2012). Available at SSRN: https://ssrn.com/abstract=2724535 or http://dx.doi.org/10.2139/ssrn.2724535

Yuliya Plyakha

Universite du Luxembourg - School of Finance ( email )

4 Rue Albert Borschette
Luxembourg, L-1246
Luxembourg

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

Grigory Vilkov (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

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