Grinold - proper alpha coverage

[Tipo]

R70.P2.T8.Grinold page 16

This is whats written in the BT notes:
What happens if we forecast returns on stocks that are not in the benchmark?

• We can always handle that by expanding the benchmark to include those stocks, albeit with zero weight. This keeps stock n in the benchmark, but with no weight in determining the benchmark return or risk

I dont quite get it? Whats the point of including them in the benchmark if we are assigning it a weight of 0. AFAIK, it doesnt change anything does it?

 

[QuantMan2318]

Well, I thought about that one too, since, the stock isn't in the benchmark, it shouldn't affect the Risk/Return of the Benchmark, I think that's the point in attaching a weight of zero to that stock in the Benchmark. However, we are also forecasting alphas on those stocks wrt. to the benchmark, therefore, this requires the computation of Betas of the same with respect to the Benchmark portfolio which in turn requires that the stock is 'considered' for these purposes in the Benchmark for comparison purposes.

This is just my line of reasoning. I may be wrong also.