Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation
University of Notre Dame
New York University (NYU) - Department of Finance; Yale School of Management; BlackRock, Inc
Dartmouth College; NBER
January 21, 2010
EFA 2009 Bergen Meetings Paper
AFA 2010 Atlanta Meetings Paper
Standard 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 primarily arise 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 explore alternative ways to construct these factors and propose alternative models constructed from common and easily tradable benchmark indices. The index-based models outperform the standard models in common applications such as performance evaluation of mutual fund managers.
Number of Pages in PDF File: 54
Keywords: performance evaluation, benchmark index, factor model, Fama-French, Carhart
JEL Classification: G10, G12, G14, G20, G23
Date posted: March 26, 2008 ; Last revised: January 26, 2010
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