DEFINITION of 'Benchmark Error'

A situation in which the wrong benchmark is selected in a financial model. This error can create large dispersions in an analyst or academic's data, but can easily be avoided by selecting the most appropriate benchmark at the onset of an analysis.

BREAKING DOWN 'Benchmark Error'

When creating a market portfolio under the capital asset pricing model (CAPM), it is important to use the most appropriate benchmark, or market, in your calculations. If, for example, you want to create a portfolio of American stocks using the CAPM, you would not use the Nikkei - a Japanese index - as your benchmark.

Accordingly, if you want to compare your portfolio returns, you should use an index that contains similar stocks. For example, if your portfolio is tech-heavy, you should use the Nasdaq as your benchmark, rather than the S&P 500.

RELATED TERMS
  1. Tracking Error

    A divergence between the price behavior of a position or a portfolio ...
  2. Benchmark

    A standard against which the performance of a security, mutual ...
  3. Active Return

    The percentage gain or loss of an investment relative to the ...
  4. Dispersion

    A statistical term describing the size of the range of values ...
  5. Active Risk

    A type of risk that a fund or managed portfolio creates as it ...
  6. International Capital Asset Pricing ...

    A financial model that extends the concept of the capital asset ...
Related Articles
  1. Investing

    What's a Benchmark?

    A benchmark is a standard investors choose to gauge the performance of their portfolios.
  2. Investing

    Benchmark To Show Winning Returns

    You can't win if you don't keep score. Read on to learn how to measure your returns.
  3. Investing

    How to Select and Build a Benchmark to Measure Portfolio Performance

    How to select and build a benchmark to measure the performance of your investment portfolio
  4. Investing

    How to Use a Benchmark to Evaluate a Portfolio

    What is an investment benchmark and how is it used to evaluate the risk and return in a portfolio.
  5. Managing Wealth

    Is Your Portfolio Beating Its Benchmark?

    Compare portfolio manager performance using the information ratio.
  6. Investing

    3 Reasons Tracking Error Matters

    Discover three ways investors can use tracking error to measure performance for a mutual fund or ETF, whether indexed or actively managed.
  7. Investing

    Benchmark Your Returns With Indexes

    If your portfolio is always falling short, you may not be making an apples-to-apples comparison.
  8. Investing

    Capital Asset Pricing Model - CAPM

    CAPM is a model that describes the relationship between risk and expected return.
  9. Investing

    Calculating Tracking Error

    Tracking error is the difference between the return on a portfolio or fund, and the benchmark it is expected to mirror (or track).
  10. Managing Wealth

    3 Steps to Assess Your Portfolio's Annual Performance

    Learn about three simple steps you can use to evaluate the annual performance of your investment portfolio, and why rate of return isn't enough.
RELATED FAQS
  1. What should I use as a benchmark for my small-cap stock portfolio?

    When creating a stock portfolio, it is important to have a benchmark against which you can compare your returns. Comparing ... Read Answer >>
  2. What are the main benchmarks that track the banking sector?

    Read about the most important benchmarks that can be used to track the banking sector, and why banking benchmarks tend to ... Read Answer >>
Hot Definitions
  1. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  2. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  3. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  4. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  5. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  6. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
Trading Center