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Choosing a Global Equity Benchmark for CAPM Beta Estimation

Article Quant Q&A · Author: László
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Summary

The document considers which global equity index to use as the market benchmark when estimating CAPM betas from monthly portfolio and benchmark returns. The portfolio is internationally diversified but has limited emerging-market exposure, raising the question of whether to use a developed-markets index or an all-country index that includes emerging markets.

The answer offers a practical selection rule based on the portfolio manager’s investment opportunity set: use an all-country benchmark if the manager could invest in emerging markets. For portfolios holding developed-market companies whose businesses have emerging-market revenue or earnings exposure, it describes the convention as using a developed-markets benchmark. The exchange gives a concise rule of thumb rather than comparative return evidence or a formal test. The appropriate benchmark therefore depends on the portfolio’s mandate and exposure; the response does not discuss index construction, currency treatment, or how benchmark choice affects beta estimates in the stated sample period.

Key ideas

  • Benchmark choice for CAPM beta estimation should reflect the manager’s available investment universe.
  • An all-country index is suggested when emerging-market investments were available to the manager.
  • A developed-markets index is suggested for developed-market holdings with indirect emerging-market business exposure.
  • The guidance is a convention and does not provide empirical comparisons of the candidate benchmarks.

Tags

EquitiesStatisticsPortfolio construction
Full text
# right benchmark for an incompletely diversified international portfolio (for a CAPM): MSCI World or MSCI ACWI IMI?


# right benchmark for an incompletely diversified international portfolio (for a CAPM): MSCI World or MSCI ACWI IMI?












I want to calculate annual excess returns on portfolios using monthly returns for a CAPM (for the assets in the portfolio as well as for the benchmark), in order to have more information on the correlations, more precise betas.

I want to use the right benchmark for all this.

Many holdings are diversified internationally, but not completely, esp. not into emerging markets (over 1999-2007). Is it appealing to use an MSCI all-world benchmark (viz. MSCI ACWI IMI GR USD converted into SEK) as people "should" have diversified, so all extra risk is, well, extra? Or it makes much more sense to compare everything to an MSCI World ( developed markets only) benchmark?

Full disclosure: This breaks down my longer question into specifics. Please bear with me. From: annual excess returns from CAPM on monthly total returns

## Answer by SCallan (score 1)

https://quant.stackexchange.com/a/10491

Did the portfolio manager have the option of investing in emerging markets? If yes, use MSCI All-World. If the portfolio has holdings based in countries with "developed markets" yet has has emerging markets exposure to revenue/earnings, the convention is to use MSCI World.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.