Abstract
Stock market indices play a central role in portfolio management and academic research. This paper reviews and discusses the main issues in index construction, especially on thinly traded stock markets and in a historical setting with deficiency of information. The main methods to deal with missing price observations are studied. As a case in point, a newly collected historical database for the Finnish stock market that covers the period from the establishment of the Helsinki Stock Exchange (HSE) in October 1912 forward is used. The HSE suffered from severe thin trading with only approximately 20% of the stocks having a daily transaction in the early part of the sample. Overall, the results show that index construction methodology have a major impact on the index as well as its statistical properties. The results also highlight the impact of corporate actions, the hardest information to obtain, on the market index performance.
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