Equity portfolios generated by functions of ranked market weights
AbstractDynamic equity portfolios can be generated by positive twice continuously differentiable functions of the ranked capitalization weights of an equity market. The return on such a portfolio relative to the market follows a stochastic differential equation that decomposes the relative return into two components: the logarithmic change in the value of the generating function, and a drift process that is of bounded variation. The method can be used to construct broad classes of stock portfolios, and has both theoretical and practical applications. Two applications of the method are presented: one offers an explanation for the size effect, the observed tendency of small stocks to have higher long-term returns than large stocks, and the other provides a rigorous analysis of the behavior of diversity-weighted indices, stock indices with weights that lie between capitalization weights and equal weights.
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Bibliographic InfoArticle provided by Springer in its journal Finance and Stochastics.
Volume (Year): 5 (2001)
Issue (Month): 4 ()
Note: received: November 1999; final version received: November 2000
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Web page: http://www.springerlink.com/content/101164/
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
- G19 - Financial Economics - - General Financial Markets - - - Other
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- Diane Wilcox & Tim Gebbie, 2013. "Factorising equity returns in an emerging market through exogenous shocks and capital flows," Papers 1306.5302, arXiv.org, revised Jul 2013.
- repec:ner:lselon:http://eprints.lse.ac.uk/44994/ is not listed on IDEAS
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