Equally weighted portfolios vs value weighted portfolios: Reasons for differing betas

Pae, Yuntaek; Sabbaghi, Navid

doi:10.1016/j.jfs.2015.04.006

Cited by 11 publications

(7 citation statements)

References 20 publications

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“…In terms of Sharpe ratio, the value‐weighted All‐Pair portfolio outperforms the equally weighted one by 0.11. Note that this finding is consistent with the literature (see Pae & Sabbaghi, ; Plyakha, Uppal & Vilkov, )…”

Section: Profitability Of Pairs‐tradingsupporting

confidence: 93%

Pairs‐trading and spread persistence in the European stock market

Figuerola‐Ferretti

Paraskevopoulos

Tang

2018

Journal of Futures Markets

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In this paper, we adapt the demand and supply framework introduced by Figuerola-Ferretti and Gonzalo (Journal of Econometrics, 2010) to illustrate the dynamics of pairs-trading. We underline the process by which a finite elasticity of demand for spread trading determines the speed of mean reversion and pairstrading profitability. A persistence-dependent trading trigger is introduced accordingly. Applied to STOXX Europe 600-traded equities, our strategy exploits price leadership for portfolio replication purposes and delivers Sharpe ratios that outperform the benchmark rules used in the literature. Portfolio performance and mean reversion are enhanced after firm fundamental factor restrictions are imposed. K E Y W O R D S cointegration, error persistence, pairs-trading, price discovery, trading trigger J E L C L A S S I F I C A T I O N C58, G11, G12, G14 | INTRODUCTIONShort-term price discrepancies are common across assets that are imperfectly integrated. Pairs-trading strategies are designed to earn profits from relative mispricings of closely related assets. This paper exploits commonalities arising from cointegrated assets to model relative value arbitrage via pairs-trading strategies. Pairs-trading belongs to the family of convergence trade strategies. It relies on a well-known trading rule for cointegrated price series based on simultaneous long-short positions that are closed when prices revert to a long-run relationship. When an investor opens a position he shorts the outperformer and longs the underperformer, until the mispricing is eliminated. We extend the Figuerola-Ferretti and Gonzalo (2010) (FFG hereafter) demand and supply framework to describe price dynamics in two distinct but cointegrated assets and show how market participants exploit temporary mispricings performing pairs-trading strategies. The setup requires a finite elasticity of arbitrage services and cointegration error persistence. It evolves around the speed by which arbitrageurs restore equilibrium allowing the measurement of price discovery for portfolio replication purposes and arbitrage profit determination. A market is regarded as dominant in this framework if it concentrates a larger number of participants. Cointegration, therefore, guarantees price convergence that is represented in terms of a stationary error correction term. A trading trigger is derived, which is linked to the degree of persistence of the cointegration error so that a higher stationarity requires a lower trading trigger. This paper is related to Gatev, Goetzmann, and Rouwenhorst (2006) (GGR hereafter), who examine the performance of pairs-trading using the daily U.S. stock return data. GGR performs pairs selection using the minimum-distance algorithm.J Futures Markets. 2018;38:998-1023. wileyonlinelibrary.com/journal/fut 998 | They find economically and statistically significant excess returns of around 11% per annum. Following GGR, Andrade, di Pietro, and Seasholes (2005); Broussard and Vaihekoski (2012); and Bowen and Hutchinson (2016) apply the algorithm to As...

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Section: Profitability Of Pairs‐tradingsupporting

confidence: 93%

Pairs‐trading and spread persistence in the European stock market

Figuerola‐Ferretti

Paraskevopoulos

Tang

2018

Journal of Futures Markets

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“…The latter represents an improvement of 21% when compared to the equal-weighted all-pair portfolio. Note that this finding is consistent with the literature (See Plyakha et al (2012) and Pae and Sabbaghi (2015)).…”

Section: The Baseline Resultssupporting

confidence: 94%

Pairs Trading and Spread Persistence in the European Stock Market

Figuerola‐Ferretti

Paraskevopoulos

Tang³

2017

SSRN Journal

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In this paper, we adapt the demand and supply framework introduced by Figuerola‐Ferretti and Gonzalo (Journal of Econometrics, 2010) to illustrate the dynamics of Pairs‐trading. We underline the process by which a finite elasticity of demand for spread trading determines the speed of mean reversion and pairs‐trading profitability. A persistence‐dependent trading trigger is introduced accordingly. Applied to STOXX Europe 600–traded equities, our strategy exploits price leadership for portfolio replication purposes and delivers Sharpe ratios that outperform the benchmark rules used in the literature. Portfolio performance and mean reversion are enhanced after firm fundamental factor restrictions are imposed.

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“…Benjamin Graham and Joel Greenblatt are among the investors that form portfolios (Rani, 2019). Pae and Sabbaghi (2015) describe two types of portfolio formation based on weighting: equally weighted and value-weighted. Equally weighted portfolios allocate capital equally to issuers, assuming that they have the same value.…”

Section: Portfoliomentioning

confidence: 99%

Investment strategy on indonesia islamic stocks using Greenblatt Magic Formula

Setiawan,

Fitri,

Muthohharoh

et al. 2023

Intenational. J. financial account. management

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Purpose: This study analyzes the portfolio form based on the Magic Formula investment strategy introduced by Greenblatt (2006). Research methodology: The portfolio formed is evaluated using the Sharpe, Treynor, and Jensen indices. Results: The results show that the Magic Formula investment portfolio provides higher returns than the reference index from June 2018 to May 2021, specifically -1.45% compared to -3.26%. The performance evaluation value of the Magic Formula investment portfolio was better than that of the reference index. Limitations: Although the Magic Formula portfolio performs well during the study period, investment portfolios can also be built and evaluated using other portfolio formulas. Contribution: This evidence shows that the Greenblatt Magic Formula investment strategy performs well because it can provide a greater return with less risk.

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Equally weighted portfolios vs value weighted portfolios: Reasons for differing betas

Cited by 11 publications

References 20 publications

Pairs‐trading and spread persistence in the European stock market

Pairs‐trading and spread persistence in the European stock market

Pairs Trading and Spread Persistence in the European Stock Market

Investment strategy on indonesia islamic stocks using Greenblatt Magic Formula

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