A star investment manager's skill might just be a mathematical trick caused by how we measure the stock market.
Perception of alpha or superior performance can be created mechanically by the way market benchmarks are constructed. In a perfectly efficient market where no one has any special skill, some managers will still look like geniuses because of the geometry of the index. We pay massive fees to fund managers who claim to be able to beat the market. This research suggests that much of this star power is actually a mathematical artifact rather than actual talent. Your high-performing fund might just be benefiting from a fluke in the formula used to track it.
The Alpha Illusion: Market Proxy Geometry and the Mechanical Reallocation of CAPM Performance
SSRN · 5336224
The intercept (alpha) in empirical asset pricing is commonly interpreted as evidence of market inefficiency, investment skill, or omitted risk. Focusing on the CAPM, this study shows that even under the efficient market hypothesis (EMH) null, nonzero empirical alpha can arise mechanically when discretely recorded returns are evaluated against an own-inclusion value-weighted market proxy. In a closed value-weighted system, intercept-included regressions reallocate realized disturbances across alp