Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation
54 Pages Posted: 26 Mar 2008 Last revised: 26 Jan 2010
Date Written: January 21, 2010
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.
Keywords: performance evaluation, benchmark index, factor model, Fama-French, Carhart
JEL Classification: G10, G12, G14, G20, G23
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