How did the Dow do today?

Paul J Haensly ()
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Paul J Haensly: School of Business, The University of Texas of the Permian Basin, 4901 E. University Blvd

Journal of Asset Management, 2003, vol. 4, issue 4, No 4, 258-276

Abstract: Abstract Daily change in the Dow Jones Industrial Average (DJIA) is a biased and imprecise measure of actual change in the US stock market, whether measured as capital appreciation or total return, despite high correlations with other market indexes. Because it omits cash dividends, the Dow underestimates daily market total return. This paper shows, however, that the index also understates daily market capital appreciation because it is less diversified than the market. Specifically, the Dow is a large-cap index, so it underperforms the US market over the long run owing to the small-stock risk premium. The DJIA overstates daily volatility primarily because the index is less diversified than the market and thus has a significant diversifiable component to its risk. Furthermore, large daily volatility makes the DJIA a poor tool for drawing inferences about actual daily change in either US or international stock markets. Given an observed daily change in the Dow, confidence intervals for the market return can be constructed, but these intervals may prove too wide to provide much information.

Keywords: stock market indexes; Dow Jones Industrial Average; statistical estimation (search for similar items in EconPapers)
Date: 2003
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DOI: 10.1057/palgrave.jam.2240107

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