Benchmark Error


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.

  1. Benchmark

    A standard against which the performance of a security, mutual ...
  2. Nasdaq

    A global electronic marketplace for buying and selling securities, ...
  3. Nikkei

    Short for Japan's Nikkei 225 Stock Average, the leading and most-respected ...
  4. Model Risk

    A type of risk that occurs when a financial model used to measure ...
  5. Standard & Poor's 500 Index - S&P ...

    An index of 500 stocks chosen for market size, liquidity and ...
  6. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
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