Choice Among Alternative Benchmarks: An Asset Pricing Approach

25 Pages Posted: 19 Apr 2014 Last revised: 30 Sep 2014

See all articles by Stephen J. Brown

Stephen J. Brown

New York University - Stern School of Business

John C. Handley

University of Melbourne - Department of Finance

Paul Lajbcygier

Monash University - Department of Banking & Finance

Date Written: September 27, 2014

Abstract

This paper provides an asset pricing rationale for choosing among alternative ways to group securities in applied corporate finance settings. Explicit reference to the asset pricing paradigm has become less prevalent in the empirical corporate finance literature, where there has emerged a preference for grouping securities on the basis of the financial characteristics of the firm and on industry affiliation. We propose a new approach using basis assets that is consistent with the asset pricing paradigm and which explains significantly more of the cross sectional dispersion in asset returns using Generalized Least Squares applied on a security by security basis. A main result of our paper is that this asset-pricing-based approach justifies the use of industrial classifications to construct matched samples and appropriate benchmark performance comparisons.

Keywords: asset pricing, risk classes, industry benchmarks, basis assets

JEL Classification: G12, G32

Suggested Citation

Brown, Stephen J. and Handley, John C. and Lajbcygier, Paul, Choice Among Alternative Benchmarks: An Asset Pricing Approach (September 27, 2014). Available at SSRN: https://ssrn.com/abstract=2426277 or http://dx.doi.org/10.2139/ssrn.2426277

Stephen J. Brown (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0306 (Phone)
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John C. Handley

University of Melbourne - Department of Finance ( email )

Victoria
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Australia
(61) 3 8344 7663 (Phone)
(61) 3 8344 6914 (Fax)

Paul Lajbcygier

Monash University - Department of Banking & Finance ( email )

23 Innovation Walk
Wellington Road
Clayton, Victoria 3800
Australia

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