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

• Tax shield and the number of component stocks cause the systematic risk difference between equally weighted portfolios and value weighted portfolios.
• The difference in systematic risk (β) depends on the default risk of component companies.
• Without noise market hypothesis, the systematic risk difference between equally weighted portfolios and value weighted portfolios exists in an efficient market.
• The systematic risk difference between the two weighting methods is not a market anomaly.

We prove that constituent companies’ capital structure and tax shield cause the difference in systematic risk between an equally weighted portfolio and a value weighted portfolio in an efficient market where the CAPM holds. The difference in systematic risk has positive association with component companies’ default risk.