Abstract
Using the Modigliani-Miller (MM) theorem and the Capital Asset Pricing Model (CAPM), we prove that equally weighted portfolios have higher expected return than value weighted portfolios when the market premium is positive, bankruptcy costs do not exist, and tax shields exist. This paper also proves that equally weighted portfolios have higher volatility than value weighted portfolios when bankruptcy costs do not exist and tax shields exist. Furthermore, we prove that diff erences between an equally weighted and a value weighted portfolio pair in terms of return and volatility increase as we add more assets to each portfolio. Using datasets that include the Ken-French Data Library and equities in the S&P500 index, we provide empirical evidence that supports these theoretical results in this paper.
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