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. Nasdaq

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

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

    A type of risk that occurs when a financial model used to measure ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  5. Standard & Poor's 500 Index - S&P ...

    An index of 500 stocks chosen for market size, liquidity and ...
  6. Benchmark

    A standard against which the performance of a security, mutual ...
Related Articles
  1. Investing Basics

    Long-Term Investing: Hot Or Not?

    Forget the latest craze - you're more likely to succeed with a buy-and-hold strategy.
  2. Mutual Funds & ETFs

    The Hidden Differences Between Index Funds

    These funds don't all match index returns. Find out how to avoid costly surprises.
  3. Mutual Funds & ETFs

    Benchmark Your Returns With Indexes

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

    What Does In Specie Mean?

    In specie describes the distribution of an asset in its physical form instead of cash.
  5. Economics

    Calculating Cross Elasticity of Demand

    Cross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
  6. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  7. Fundamental Analysis

    Emerging Markets: Analyzing Chile's GDP

    Chile has become one of the great economic success stories of Latin America.
  8. Investing

    Watch Your Duration When Rates Rise

    While recent market volatility is leading investors to look for the nearest exit, here are some suggestions for bond exposure in attractive sectors.
  9. Economics

    Explaining Capital Flows

    The movement of money for investing, trade or business production, is commonly referred to as capital flows.
  10. Investing

    Yellow Light Trade Risk Management

    Being in the stock market for so long I tend to look at the world through the eyes of a trader, but how to decide when we are presented with two options?
  1. Is it possible to invest in an index?

    First, let's review the definition of an index. An index is essentially an imaginary portfolio of securities representing ... Read Full Answer >>
  2. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  3. How can I use a regression to see the correlation between prices and interest rates?

    In statistics, regression analysis is a widely used technique to uncover relationships among variables and determine whether ... Read Full Answer >>
  4. How is the expected market return determined when calculating market risk premium?

    In some cases, brokerage firms provide an expected market rate of return based on an investor's portfolio composition, risk ... Read Full Answer >>
  5. How do I calculate a modified duration using Matlab?

    The modified duration gauges the sensitivity of the fixed income securities to changes in interest rates. To calculate the ... Read Full Answer >>
  6. How do I calculate the rule of 72 using Matlab?

    In finance, the rule of 72 is a useful shortcut to assess how long it takes an investment to double given its annual growth ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!