Pricing Errors as Positive Alpha
30 Pages Posted: 5 Jan 2019 Last revised: 5 Dec 2019
Date Written: April 1, 2019
We consider a simple equilibrium model of active fund managers and consumers. Our model features zero net-of-fee alpha in equilibrium. However, using a common, but misspecified, model for the stochastic discount factor (SDF) implies positive measured alpha. This note, thus, warns against interpreting pricing errors as alpha: That is only true if the SDF is correctly specified. Our model is tractable enough to provide closed form solutions for all quantities of interest.
Keywords: Active Management, Negative Performance Puzzle, Pricing Kernel
JEL Classification: G23, G21, G11
Suggested Citation: Suggested Citation