Equal-Weighting Versus Value-Weighting: Theory and Practice

30 Pages Posted: 24 Mar 2018

See all articles by Nan Qin

Nan Qin

College of Business, Northern Illinois University

Vijay Singal

Virginia Tech

Date Written: May 19, 2017

Abstract

Stocks exhibit higher expected returns when random mispricing presents (Brennan and Wang, 2010). Based on constituents of several major U.S. stock indexes from 2002 to 2016, we show that equally-weighted portfolios could benefit from this mispricing return premium and deliver abnormal returns to investors. Specifically, this outperformance could be realized after deducting trading costs and taxes when portfolio size is medium (e.g. $500 million in 2002 dollar) or smaller, but diminishes for larger portfolios. The findings of this paper suggest that, instead of relying on the popular value-weighted portfolios, investors could consider equal-weighting strategies for higher risk-adjusted returns. The implication is that current level of market inefficiency is sufficiently high so that simple equal-weighting strategies could generate positive abnormal returns.

Keywords: Indexing, Equally-Weighted Index, Stock Return Bias, Jensen’s Inequality, Capital Gains Tax

JEL Classification: G14, G23

Suggested Citation

Qin, Nan and Singal, Vijay, Equal-Weighting Versus Value-Weighting: Theory and Practice (May 19, 2017). Available at SSRN: https://ssrn.com/abstract=

Nan Qin (Contact Author)

College of Business, Northern Illinois University

1425 W. Lincoln Hwy.
DEKALB, IL 60115
United States

Vijay Singal

Virginia Tech ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States
5402317750 (Phone)

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