Equal-weighting and value-weighting: which one is better?

Prior research shows that noisy prices can introduce biases in returns causing equal-weighted portfolios to outperform value-weighted portfolios. In this paper, we reevaluate the superiority of EW portfolios in the presence of market frictions. We find that trading costs have limited impact on the performance of EW portfolios, while taxes cause the performance of both EW and VW portfolios to deteriorate by a similar magnitude leaving the superiority of EW portfolios intact. Besides mispricing, the results for small cap portfolios may also be affected by the size effect. Overall, EW portfolios earn annualized risk-adjusted returns between 1.23% and 1.79% even after accounting for trading costs and taxes. [ABSTRACT FROM AUTHOR]