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.

RELATED TERMS
  1. Tracking Error

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

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

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

    A financial model that extends the concept of the capital asset ...
  5. Benchmark Bond

    A bond that provides a standard against which the performance ...
  6. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's ...
Related Articles
  1. ETFs & Mutual Funds

    Benchmark To Show Winning Returns

    You can't win if you don't keep score. Read on to learn how to measure your returns.
  2. Managing Wealth

    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
  3. Managing Wealth

    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.
  4. Managing Wealth

    Is Your Portfolio Beating Its Benchmark?

    Compare portfolio manager performance using the information ratio.
  5. ETFs & Mutual Funds

    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.
  6. Investing

    Capital Asset Pricing Model - CAPM

    CAPM is a model that describes the relationship between risk and expected return.
  7. 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).
  8. ETFs & Mutual Funds

    Active Management: Is It Working For You?

    There are guidelines to be followed when comparing an actively-managed investment strategy with a benchmark.
  9. Investing

    The Capital Asset Pricing (CAPM) Model: Pros and Cons

    CAPM, while criticized for its unrealistic assumptions, provides a more useful outcome than either the DDM or WACC in many situations.
  10. Trading

    Make Your Portfolio Safer With Risky Investments

    A high-risk security can reduce risk overall. Find out how it works.
RELATED FAQS
  1. How do I grade my financial adviser?

    I have had the same financial adviser for the past 12 years, obviously through some tough financial times. However, I don't ... Read Answer >>
  2. 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 >>
  3. 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 >>
  4. Is tracking error a significant measure for determining ex-post risk?

    Before we answer your question, let's first define tracking error and ex-post risk. Tracking error refers to the amount by ... Read Answer >>
  5. What are the pros and cons of using the S&P 500 as a benchmark?

    Learn about the advantages and disadvantages of using the S&P 500 as a benchmark for portfolio performance, and understand ... Read Answer >>
  6. How can I calculate the tracking error of an ETF or indexed mutual fund?

    Understand what tracking error is and learn about the significant difference it can represent for investors who favor index ... Read Answer >>
Hot Definitions
  1. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  2. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  3. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  4. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  5. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
  6. Security

    A financial instrument that represents an ownership position in a publicly-traded corporation (stock), a creditor relationship ...
Trading Center