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A new weighting-scheme for equity indexes

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  • Aboura, Sofiane
  • Chevallier, Julien

Abstract

This paper proposes a novel methodology for computing a cross capitalization-weighted index, coined CCWI, that characterizes the most influential stocks that drive the index. The methodology, based on the factor analysis approach combined with the Equi-correlation model of Engle and Kelly (2012), encapsulates all the main information to replicate any given large equity stock index. We build a proxy that tracks accurately the S&P 500 while reducing the cost of duplication for large equity indexes with the methodology combining the PCA approach and the DECO model. We provide an application to the S&P 500 by constructing an aggregate stock index composed of the most influential stocks. The analysis reveals that the CCWI is useful for asset and risk management. Robustness checks expand the equity index universe to MIB, TSX, CAC, DAX, FTSE, NIKKEI, HSI and DJIA, both during full- and sub-periods.

Suggested Citation

  • Aboura, Sofiane & Chevallier, Julien, 2017. "A new weighting-scheme for equity indexes," International Review of Financial Analysis, Elsevier, vol. 54(C), pages 159-175.
    • Handle: RePEc:eee:finana:v:54:y:2017:i:c:p:159-175
    DOI: 10.1016/j.irfa.2016.11.004
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    Cited by:

    1. Charles Shaw, 2022. "Portfolio Diversification Revisited," Papers 2204.13398, arXiv.org.
    2. Azra Zaimovic & Adna Omanovic & Almira Arnaut-Berilo, 2021. "How Many Stocks Are Sufficient for Equity Portfolio Diversification? A Review of the Literature," JRFM, MDPI, vol. 14(11), pages 1-30, November.

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    More about this item

    Keywords

    Equity index; Factor analysis; Equi-correlation; Weighting scheme;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G01 - Financial Economics - - General - - - Financial Crises
    • F15 - International Economics - - Trade - - - Economic Integration

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