Betas, Benchmarks and Beating the Market

Abstract

We give an explicit formulaic algorithm and source code for building long-only benchmark portfolios and then using these benchmarks in long-only market outperformance strategies. The benchmarks (or the corresponding betas) do not involve any principal components, nor do they require iterations. Instead, we use a multifactor risk model (which utilizes multilevel industry classification or clustering) specifically tailored to long-only benchmark portfolios to compute their weights, which are explicitly positive in our construction.

Keywords: Market, Beta, Benchmark, Alpha, Trading, Portfolio, Stock, Equity, Optimization, Sharpe Ratio, Risk, Return, Expected, Factor, Loading, Specific, Idiosyncratic, Volatility, Variance, Covariance, Correlation, Matrix, Bound, Cost, Constraint, Regression, Weight, Source Code, Index, Investment, Long

JEL Classification: G00, G10, G11, G12, G23