Anon

66 The Basics of financial economeTrics

indexes.^14 The rationale is that potential clients can buy a combination of
specialized index funds to replicate a style of investing. A benchmark can
be created using regression analysis that adjusts for a manager’s index-like
tendencies. Such a benchmark is called a Sharpe benchmark.
The 10 mutually exclusive indexes suggested by Sharpe to provide
asset class diversification are (1) the Russell Price-Drive Stock Index (an
index of large value stocks), (2) the Russell Earnings-Growth Stock Index
(an index of large growth stocks), (3) the Russell 2000 Small Stock Index,
(4) a 90-Day Bill Index, (5) the Lehman Intermediate Government Bond
Index, (6) the Lehman Long-Term Government Bond Index, (7) the Lehman
Corporate Bond Index, (8) the Lehman Mortgage-Backed Securities Index,
(9) the Salomon Smith Barney Non-U.S. Government Bond Index, and
(10) the Financial Times Actuaries Euro-Pacific Index.^15

TAbLE 3.6 Results of Regression for Forecasting 10-Year Treasury Yield

Regression Statistics

Multiple R^2 0.9083

R^2 0.8250

Adjusted R^2 0.8243

Standard Error 1.033764

Observations 482

Analysis of Variance

df SS MS F Significance F

Regression 2 2413.914 1206.957 1129.404 4.8E-182

Residual 479 511.8918 1.068668

Total 481 2925.806

Coefficients

Standard

Error t

Statistics

p-value

Intercept 1.89674 0.147593 12.85 1.1E-32

Expected Inflation 0.996937 0.021558 46.24 9.1E-179

Real Rate 0.352416 0.039058 9.02 4.45E-18

(^14) William F. Sharpe, “Determining a Fund’s Effective Asset Mix,” Investment Man-
agement Review 9 (September–October 1988): 16–29.
(^15) At the time that Sharpe introduced his model, the bond indexes were published by
the investment banking firms of Shearson-Lehman and Salomon Brothers.