Abstract
Based on the work of Brandt, Santa-Clara and Valkanov (2009), we formulate an index tracking and enhanced indexation model using a parametric approach. The portfolio weights are modeled as functions of assets characteristics and similarity measures of the assets with the index to track. This approach permits to handle non-linear and non-convex objectives functions that are common in index tracking and enhanced indexation. An empirical implementation and analysis of the characteristics are presented for the S&P500 index.
Highlights
Index tracking is a type of passive management strategy which consists of designing a portfolio to replicate the behavior of a broad market index
We propose a parametric approach for index tracking and enhanced indexation based on the work of Brandt, Santa-Clara, and Valkanov (2009)
Even though there are multiple approaches for rebalancing a tracking portfolio, we only describe two general cases which can be handled by the parametric approach
Summary
Index tracking is a type of passive management strategy which consists of designing a portfolio (tracking portfolio or index fund) to replicate the behavior of a broad market index. The objective in the enhanced indexation problem is to maximize alpha while the beta of the portfolio remains close to one, or to maximize excess return (over the index) by keeping the tracking error bounded to some quantity. Our objective function decomposes (approximately) the variance of the tracking error or the portfolio beta into the correlation coefficient of the portfolio and the index and the ratio of their standard deviations. We can analyze how these strategies change according to the importance given to the tracking or enhanced components of the objective These features give the investor more information about the portfolio holdings than typical approaches in the literature. We implement the parametric approach to build a tracking or enhanced tracking portfolio for the S&P500 index, using as characteristics market capitalization, alpha and beta of the individual stocks.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
