Testing Equity Portfolios for Alpha Bias: An Exercise for Student Investment Funds

Abstract

We present an exercise that guides students through the rationale and techniques for identifying and correcting for alpha bias in the reported performance of equity portfolios. The exercise is particularly relevant for Student Investment Fund programs that invest actual money, as the historical performance of the class portfolio can be used in the activity, which creates an additional level of engagement for students. Students learn why portfolios that emphasize small-capitalization and/or value stocks tend to display a positive alpha bias (overstating performance), and why portfolios that emphasize large-capitalization and/or growth stocks tend to display a negative alpha bias (understating performance).