Critical Finance Review > Vol 2 > Issue 1

Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation

Martijn Cremers, University of Notre Dame, Mendoza College of Business, , Antti Petajisto, Corresponding author. NYU Stern, , Eric Zitzewitz, Dartmouth College and NBER,
Suggested Citation
Martijn Cremers, Antti Petajisto and Eric Zitzewitz (2013), "Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation", Critical Finance Review: Vol. 2: No. 1, pp 001-048.

Publication Date: 01 Jul 2013
© 2013 M. Cremers, A. Petajisto, and E. Zitzewitz


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In this article:
1. Introduction 
2. Defining a Good Benchmark Model 
3. Data 
4. Alphas of Benchmark Indices 
5. Choosing an Alternative Approach 
6. Conclusions 


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 that 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 due to the inclusion of other types of securities such as closed-end funds. We propose small methodological changes to the Fama-French factors to eliminate the nonzero alphas, and we also propose factor models based on common and tradable benchmark indices. Both kinds of alternative models improve performance evaluation of actively managed portfolios with the index-based models exhibiting the best performance.