A Guide to Equity Index Construction (2nd Edition)
First published:
ISBN: 9781782724483
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Construction method
Construction method
Preface
Acknowledgements
Introduction
Which benchmark?
Modern portfolio theory and the benchmark index
Sampling and selection
Construction method
Making the index investable
Collection and processing of data
Servicing and maintenance
How to handle industries
How to handle countries and currencies
Factor indices and smart beta
Innovative indices
The commercial indices
Indexation and exchange-traded funds
Bespoke “custom-made” indices
Tying it all together
Appendix: The GICS methodology
Bibliography
Disclaimer
INTRODUCTION
“Statistics may be defined as a body of methods for making wise decisions in the face of uncertainty.”
—W. A. Wallis
This chapter further explores the methodology of establishing index construction. It is important to emphasise that the mathematical foundations of index construction stem from various fields, primarily driven by the need to measure inflation. While the formulas differ, their essence lies in establishing an unbiased mean of stock prices from a sample of securities.
Definition 5.1. Index method The index method delineates the rules for selecting and weighting components, along with the methodology for calculating the index value. Different indices may employ various methods, with the choice dependent on the objectives and preferences of the index provider.
To develop an index replicating the market portfolio, one must adhere to a construction methodology comprising the following three key components.
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Selection of a universe, comprising a finite set of shares for investment.
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Determination of precisely defined quantities, qualities and/or characteristics.
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Establishment of a statistical measure or formula combining values of selected shares into a single index
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