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Monday, May 4, 2009

Choice of benchmark

Published betas typically use a stock market index such as S&P 500 as a benchmark. The benchmark should be chosen to be similar to the other assets chosen by the investor. Other choices may be an international index such as the MSCI EAFE. The choice of the index need not reflect the portfolio under question: beta for e.g. gold bars compared to the S&P 500 may be low or negative carrying the information that gold does not track stocks and may provide a mechanism for reducing risk. The restriction to stocks as a benchmark is somewhat arbitrary. Sometimes the market is defined as "all investable assets" (see Roll's critique); unfortunately, this includes lots of things for which returns may be hard to measure.

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