Fundamental Portfolio Outperforms the Market Portfolio

TL;DR

This paper provides a theoretical foundation explaining why the fundamental portfolio often outperforms the market portfolio, based on stock price reversion assumptions, aligning with empirical evidence.

Contribution

It introduces a theoretical model linking stock price reversion to fundamental values, explaining the fundamental portfolio's outperformance.

Findings

Fundamental portfolio outperforms market when stock prices revert strongly to fundamentals.

Weak reversion leads to underperformance of the fundamental portfolio.

Theoretical support aligns with empirical observations.

Abstract

There is substantial empirical evidence showing the fundamental portfolio outperforming the market portfolio. Here a theoretical foundation is laid that supports this empirical research. Assuming stock prices revert around fundamental prices with sufficient strength and symmetry, the fundamental portfolio outperforms the market portfolio in expectation. If reversion toward the fundamental price is not sufficiently strong, then the fundamental portfolio underperforms the market portfolio in expectation.