Sat, Dec 20, 2014
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Industry Updates

EDHEC-Risk study finds no theoretical or empirical justification for cap-weighted indices

Tuesday, June 29, 2010
Opalesque Industry Update - After the financial crisis and the accompanying falls in the stock markets, many commentators have questioned the appropriateness of tracking cap-weighted indices. These indices are particularly inefficient and, through their momentum properties, favour the emergence of speculative bubbles.

New research from the EDHEC-Risk Institute shows that financial theory, despite widely-held views to the contrary, does not support investment in these types of indices. It is therefore urgent for investors to seek alternatives to these indices which are justified by neither fact nor theory.

The three main conclusions of the research are the following:

1.A cap-weighted stock market index is not the market portfolio of financial theory (the Capital Asset Pricing Model (CAPM) theory is often evoked to show that cap-weighted stock market indices are efficient portfolios and attractive investments). That it is not is clear from the choices made in empirical studies that attempt to come up with reasonable proxies for the market portfolio. These studies attach great importance to including many more stocks than indices do, and their proxies of the market portfolio include bonds, real estate, and non-tradable assets such as human capital.

2.Even if it were possible to construct and hold the market portfolio, the theory does not predict that the market portfolio is efficient unless we make highly unrealistic assumptions. In fact, the authors of the seminal academic research in the 1950s and 1960s, Harry Markowitz and William Sharpe, have themselves emphasised (Sharpe (1991) and Markowitz (2005)) that the market portfolio may not be efficient in a more realistic setting.

3.In view of these arguments, financial theory alone does not justify the current practice of cap-weighting. In fact, from a theoretical perspective, cap-weighted stock market indices seem to offer no particular advantage.

The EDHEC-Risk Institute Publication, “Does Finance Theory Make the Case for Capitalisation-Weighted Indexing?” can be downloaded by pressing [Ctrl] and clicking on the following link: Source

- FG

What do you think?

   Use "anonymous" as my name    |   Alert me via email on new comments   |   
Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing


  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. Investing - Big hedge funds win again on PetSmart, Riverbed, RBS sells real estate loans to hedge fund Cerberus, Talisman energy speculation: Which hedge funds could benefit?[more]

    Big hedge funds win again on PetSmart, Riverbed From CNBC.com: Another week, another set of wins for activist investors. On Sunday, pet supply retailer PetSmart agreed to the largest leveraged buyout of the year at $8.7 billion. Hedge fund firm JANA Partners had been pushing for a sale a

  2. Outlook - Hedge fund manager who remembers 1998 rout says prepare for pain, Bond guru Bill Gross predicts U.S. economic growth to dip to 2%[more]

    Hedge fund manager who remembers 1998 rout says prepare for pain From Bloomberg.com: Stephen Jen landed in Hong Kong in early January 1997 as Morgan Stanley’s newly minted exchange-rate strategist for Asia. He was soon working around the clock when investors began targeting the region’s

  3. Investing - Hedge funds get boost from healthcare in 2014, Paulson & Co takes stake in Salix on heels of inventory issues[more]

    Hedge funds get boost from healthcare in 2014 From Valuewalk.com: The healthcare sector started the year on a turbulent note, as stocks of many major biotechnology companies were battered. However, most of the players in this sector have bounced back. The BarclayHedge Healthcare & Biotec

  4. Comment - High fees and low performance hit hedge funds[more]

    From FT.com: Disenchantment over high fees and lackluster performance may finally be turning the tide against hedge funds, fresh data suggest. Despite generally weak returns since the global financial crisis, hedge funds have enjoyed positive net inflows every year since 2010. This helped assets und

  5. Performance - Lansdowne, Man Group, other hedge funds profit from shorts in oil, Turmoil boosts hedge funds that bet against Russia, oil, CTAs post strongest returns since December 2010[more]

    Lansdowne, Man Group, other hedge funds profit from shorts in oil From Valuewalk.com: The rising short interest in oil companies implies that the worst for oil is yet to come. Data from Markit shows that short exposure in energy sector of S&P 500 is still looming close to the highest mar