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Testing claim of beating the market

You are considering hiring an investment advisor to help you manage your portfolio. This advisor tells you that she has consistently "beaten the market" over the last 5 years. You ask the advisor to prove her claim.
a. In words, describe what it would mean for her to have "beaten the market." You may refer to CAPM as needed to develop your answer.
b. Devise a test of her claim that she has beaten the market. What data would you need to carry out this test?
c. She responds to you by saying that her portfolio has beaten the S&P 500's return for each of the past 5 years (and the S&P has gone up each of those years.) Is this proof that she has beaten the market?

Solution Preview

a. It means to have earned a rate of return in excess of that predicted by the capital market line:
Rp=rf+β(RMP)

b. We first calculate the beta of the advisor's ...

Solution Summary

How to determine whether a portfolio has beaten the market

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