The Rank Effect
We decompose returns for portfolios of bottom-ranked, lower-priced assets relative to the market into rank crossovers and changes in the relative price of those bottom-ranked assets. This decomposition is general and consistent with virtually any asset pricing model. Crossovers measure changes in rank and are smoothly increasing over time, while return fluctuations are driven by volatile relative price changes. Our results imply that in a closed, dividend-free market in which the relative price of bottom-ranked assets is approximately constant, a portfolio of those bottom-ranked assets will outperform the market portfolio over time. We show that bottom-ranked relative commodity futures prices have increased only slightly, and confirm the existence of substantial excess returns predicted by our theory. If these excess returns did not exist, then top-ranked relative prices would have had to be much higher in 2018 than those actually observed -- this would imply a radically different commodity price distribution.