A Guide to Equity Index Construction (2nd Edition)
First published:
ISBN: 9781782724483
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How to handle countries and currencies
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
“We’re trying to extend the three-factor model internationally. The scientific approach is always to say: does it work out of sample? In other words, does it work on new data, in this case, foreign stocks?”
—Eugene Fama
This chapter explores how to handle countries and currencies. The very first indices were country indices. As the financial markets globalised, investors increasingly sought out indices that encompass international countries and currencies. While, on the surface, the treatment of countries might appear analogous to that of sectors and factors, a deeper examination reveals differences. For example, there are vast disparities in the sizes of individual national economies, and their respective corporate make-up can distort the index constituents and weightings. The index constructor, therefore, faces the critical decision of preserving the representativeness of countries, or prioritising capitalisation, as discussed in earlier chapters.
Definition 10.1. Country In the context of listed securities, the term “country” typically refers to the country of origin or incorporation of a company whose securities are traded on a stock exchange. The country of listing is
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