When Does the 1/N Rule Work?

27 Pages Posted: 5 Feb 2018 Last revised: 28 Oct 2019

See all articles by Danqiao Guo

Danqiao Guo

University of Waterloo

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics; University of Waterloo

Chengguo Weng

University of Waterloo

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance; University of Waterloo, Department of Statistics & Actuarial Science

Date Written: October 28, 2019

Abstract

We propose a "1/N favorability index" to measure how favorable a market is to holding a 1/N portfolio. This index reflects the extent of difficulty for an optimized portfolio to outperform the 1/N portfolio in a specific market. A single-factor model predicts that bull markets are accompanied by a high 1/N favorability index and vice versa. We validate the model implication that the 1/N portfolio is more difficult to beat in bull markets using stock return datasets from a number of countries as well as the classic datasets used by DeMiguel et al. (2009). Our results imply that the reported good performance of the 1/N portfolio in the US equity market can be partially attributed to the long-run bullish trend in the market which gives rise to the high favorability of the market to the 1/N portfolio.

Keywords: 1/N rule, favorability index, bull and bear markets, regime-switching model

Suggested Citation

Guo, Danqiao and Boyle, Phelim P. and Weng, Chengguo and Wirjanto, Tony S., When Does the 1/N Rule Work? (October 28, 2019). Available at SSRN: https://ssrn.com/abstract=3111531 or http://dx.doi.org/10.2139/ssrn.3111531

Danqiao Guo (Contact Author)

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519 884 1970 (Phone)
519 888 1015 (Fax)

University of Waterloo

Waterloo, Ontario N2L 3G1
Canada

Chengguo Weng

University of Waterloo ( email )

M3-200 Univ Ave W
Waterloo, Ontario N2L3G1
Canada
(1)888-4567 ext.31132 (Phone)

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)

HOME PAGE: http://https://uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

University of Waterloo, Department of Statistics & Actuarial Science ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)
519-746-1875 (Fax)

HOME PAGE: http://math.uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

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