Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation
AbstractStandard Fama-French and Carhart models produce economically and statistically significant nonzero alphas, even for passive benchmark indices such as the S&P 500 and Russell 2000. We find that these alphas arise primarily from the disproportionate weight the Fama-French factors place on small value stocks, which have performed well, and from the CRSP value-weighted market index, which is historically a downward-biased benchmark for U.S. stocks. We propose small methodological changes to the Fama-French factors to eliminate the nonzero alphas, and we also propose factor models based on common and tradable benchmark indices. Both kinds of alternative models improve performance evaluation of actively managed portfolios, with the index-based models exhibiting the best performance.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18050.
Date of creation: May 2012
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Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
- G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-05-15 (All new papers)
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