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The Cross-Section of Positively Weighted Portfolios

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Abstract

This paper examines properties of mean-variance inefficient proxies<br />with respect to producing a linear relation between expected returns<br />and betas. The numerical results of a Monte Carlo simulation show<br />that in the CAPM slightly inefficient, positively weighted proxies cause<br />an almost perfect linear expected return - beta relation. Moreover, we<br />show that a strong linearity among a predefined subset of assets exists.<br />These implications are important for the interpretation of empirical<br />tests as well as for asset pricing and for the improvement of proxies’<br />benchmark properties. In contrast to current literature the results<br />suggest that the CAPM’s pricing error is small when slightly inefficient,<br />positively weighted proxies are used.

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