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Towards the Design of Better Equity Benchmarks

Rehabilitating the Tangency Portfolio from Modern Portfolio Theory

Auteurs :
Lionel Martellini

Professor of Finance and Scientific Director of the EDHEC Risk and Asset Management Research Centre

Following recent research on the relevance of idiosyncratic risk in asset pricing models, Lionel Martellini proposes to use total volatility as a model-free estimate of a stock's excess expected return, and analyze the implications in terms of the design of improved equity benchmarks.

The author finds that maximum Sharpe ratio portfolios consistent with such expected return proxies, and built upon improved estimates of the correlation parameters, significantly outperform market cap weighted schemes on a risk-adjusted basis. This analysis, which rehabilitates the role of the tangency portfolio from modern portfolio theory, suggests that better equity benchmarks can be designed, provided that a sophisticated portfolio optimization procedure is used that relies on robust estimates of moments and co-moments of stock return distributions. This paper has important potential implications for the ongoing debate on appropriate weighting schemes for equity indices.
Type :
Working Paper
Dates :
Créé le 13 octobre 2008
Complément d'informations :
Pour plus d'informations, nous vous prions de vous adresser à Séverine Anjubault, Direction de la recherche de l'EDHEC [ severine.anjubault@edhec.edu ]

Les opinions exprimées sont celles des auteurs et n'engagent pas la responsabilité de l'EDHEC.

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