Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation

Cremers, Martijn; Petäjistö, Antti; Zitzewitz, Eric

doi:10.2139/ssrn.1108856

Cited by 131 publications

(172 citation statements)

References 42 publications

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“…The use of NYSE breakpoints in the Fama and French approach also favors this over-representation of small stocks in the portfolios. The second consequence, as already noted by Cremers, Petajusto and Zitzewitz (2010), is that the Fama and French methodology underestimates the size effect by making calculations based on the return spread between 1) large cap stocks and 2) those displaying small and intermediate level of capitalization, instead basing calculations on the return spread of pure small cap stocks.…”

Section: Theoretical Frameworkmentioning

confidence: 99%

“…book-to-market) premiums, some more recent studies suggest that the premiums obtained with the Fama and French technique could be misspecified. According to a study by Cremers, Petajusto and Zitzewitz (2010), value premium is overestimated in the Fama and French framework because this methodology does not distinguish the differential impact of value effects on small and larger sized portfolios (value effect has a greater impact on smaller stock portfolios). In addition, Huij and Verbeek (2009) indicated that mimicking portfolios calculated using the Fama and French methodology could suffer from an overestimation of value premium and an underestimation of momentum factors.…”

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confidence: 99%

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Size Matters, Book Value Does Not! The Fama-French Empirical CAPM Revisited

Lambert

Hübner²

2014

SSRN Journal

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The Fama and French factors do not reliably estimate the size and book-to-market effects. Our aim is to demonstrate that these factors have been under-and overestimated, respectively, in the US market. We replaced Fama and French's independent rankings with the conditional ones introduced by Lambert and Hübner (2013), withsome additional modifications designed to improve the sorting procedure. We have been able to highlight a much stronger size effect than has conventionally been documented. As a significant related outcome, the alternative risk factors have been found to deliver less specification errors when used to price passive investment indices. Professor Marie LambertMarie Lambert is Assistant Professor at HEC-Management School of the University of Liège and the BNP Paribas Fortis and Transeo chair in Corporate Finance. Together with her two partners, Marie works on valuation guidelines for European SME transfers and more especially on the price expectation mismatch between business vendors and potential acquirers. She holds a joint Ph.D. in Finance from the Universities of Liège and Luxembourg (2010) on "Hedge Funds and Higher-Order Comoment Equity Risk Premiums". After her Ph.D., Marie was a research fellow (National Research Fund, Luxembourg)

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Section: Theoretical Frameworkmentioning

confidence: 99%

mentioning

confidence: 99%

Size Matters, Book Value Does Not! The Fama-French Empirical CAPM Revisited

Lambert

Hübner²

2014

SSRN Journal

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“…Performances were measured using the alpha generated based on the regressions using the four factors model, known here as Fama, French, and Carhart (FFC), explained by Carhart (1997) and developed based on the Fama and French (1993) model. As a robustness test, the Cremers, Petajisto, and Zitzewitz (2012) model was also used, known here as CPZ. First, the performances of portfolios containing funds with diff erent levels of R 2 and alphas were compared.…”

Section: Introductionmentioning

confidence: 99%

Predictive power of Brazilian equity fund performance using R2 as a measure of selectivity

Guzella

Campani

2017

Rev. contab. finanç.

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This paper aimed to investigate the impact of levels of selectivity on the performance of equity funds using a methodology applied for the first time ever (as far as we know) in the Brazilian market. As an indicator of the activity level of a fund, we proposed the coefficient of determination (R 2 ) of the regression of its returns over market returns. In total, 867 funds were analyzed in the period between November 2004 and October 2014. The hypothesis tested is that more selective funds perform better to compensate for their higher operating costs. This hypothesis was confirmed in the Brazilian market. Dynamic equally-weighted portfolios of funds were simulated, according to their past R 2 and alphas, with monthly rebalancing and 12-month moving windows. The portfolio of the most selective funds had a Sharpe ratio of 0.0494, on a monthly basis, while the portfolio of the least selective funds had a Sharpe ratio of -0.0314. Performance was also higher in evaluations involving excess returns, Jensen's alpha, and accumulated returns, as well as when compared to randomly selected portfolios. Moreover, past performance (as measured by Jensen's alpha) was also a predictor of future performance. Particularly, the portfolio composed by funds with a higher past alpha and lower past R 2 presented a Sharpe ratio of 0.1483 and a Jensen's alpha of 0.87% (significant at 1%), while the one composed of funds with a lower past alpha and lower activity level presented a Sharpe ratio of -0.0673 and an alpha of -0.32% (also significant at 1%).

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“…modifications of Fama-French factors) to -3.18% using Wilshire size and style indices in Sharpe (1992) style model. Cremers, Petajisto and Zitzewitz (2012), CPZ hereafter, document non-zero alphas in well diversified passive US indices, such as S&P 500 and Russell 2000 among others. They find that growth and general large cap indices exhibit significant outperformance, while value and general small cap indices significantly underperform based on Carhart (1997) four factor model alphas.…”

Section: Introductionmentioning

confidence: 99%

Alphas in Disguise: A New Approach to Uncovering Them

2015

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Fama-French (Carhart) alphas of passive indices should be zero, but recent evidence shows otherwise. Inaccuracies of factors in the performance measurement models have been put forward as the main reason for this. Some computationally intensive solutions to factor adjustment have been proposed, but are not applicable to all benchmark indices. We propose an optimisation algorithm that makes minor adjustments to the market, size, value and momentum factors to obtain zero alphas for any benchmark index. In the sample of 1281 active and 102 passive US equity mutual funds benchmarking against S&P500, our adjustment leads to augmentation of fund performance upwards in periods of index underperformance and downwards in periods of index outperformance. Overall, the adjusted alphas of both groups of funds are significantly negative, signalling poor performance. This is particularly pronounced for tracker funds, whose managers have not been successful in enhancing returns adequately to make-up for the costs involved in any of the sub-periods examined. JEL classification: G10, G11,C6

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Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation

Cited by 131 publications

References 42 publications

Size Matters, Book Value Does Not! The Fama-French Empirical CAPM Revisited

Size Matters, Book Value Does Not! The Fama-French Empirical CAPM Revisited

Predictive power of Brazilian equity fund performance using R2 as a measure of selectivity

Alphas in Disguise: A New Approach to Uncovering Them

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