Index Construction Methodology Research Articles

An empirical approach and practical framework for a decentralized Ethereum Ecosystem Index (EEI).

Stock market indices are pivotal tools for establishing market benchmarks, enabling investors to navigate risk and volatility while capitalizing on the stock market's prospects through index funds. For participants in decentralized finance (DeFi), the formulation of a token index emerges as a vital resource. Nevertheless, this endeavor is complex, encompassing challenges such as transaction fees and the variable availability of tokens, attributed to their brief history or limited liquidity. This research introduces an index tailored for the Ethereum ecosystem, the leading smart contract platform, and conducts a comparative analysis of capitalization-weighted (CW) and equal-weighted (EW) index performances. The article delineates exhaustive criteria for token eligibility, intending to serve as a comprehensive guide for fellow researchers. The results indicate a consistent superior performance of CW indices over EW indices in terms of return and risk metrics, with a 30-constituent CW index outshining its counterparts with varied constituent numbers. The recommended CW30 index demonstrates substantial advantages in comparison to established benchmarks, including prominent indices like DeFi Pulse Index (DPI) and CRypto IndeX (CRIX). Additionally, the article explores the practicality of implementing the CW30 in Layer 2 networks of the Ethereum Ecosystem, advocating for the Arbitrum infrastructure as the optimal choice for the decentralized crypto index protocol herein referred to as the Ethereum Ecosystem Index (EEI). The study's insights aspire to enrich the DeFi ecosystem, offering a nuanced understanding of network selection and a strategic framework for implementation. This research significantly enhances the existing literature on index construction and performance within the Ethereum ecosystem. To our knowledge, it represents a pioneering comprehensive analysis of an index that accurately mirrors the Ethereum market, advancing our comprehension of its intricacies and wider ramifications. Moreover, this study stands as one of the initial thorough examinations of index construction methodologies within the nascent asset class of crypto. The insights gleaned provide a pragmatic approach to index construction and introduce an index poised to serve as a benchmark for index products. In illuminating the unique facets of the Ethereum ecosystem, this research makes a substantial contribution to the current discourse on crypto, offering valuable perspectives for investors, market stakeholders, and the ongoing exploration of digital assets.

Assessing and comparing the sustainability of organic and conventional wheat farming in India: An indicator-based approach

Achieving agricultural sustainability requires a comprehensive assessment of economic, social, and environmental dynamics. This assessment must be supported by scientifically validated indicators that measure all aspects of the system. This study aims to assess and compare the indicator-based farm sustainability of wheat farming in Punjab, India, under two farming systems: conventional farming (CF) and organic farming (OF). This study is based on cross-sectional data collected through a primary survey of 348 wheat growers (143 organics and 205 conventional). A multi-stage random sampling technique was used to collect the data. Based on the Organization for Economic Cooperation and Development (OECD) 2008 index construction methodology, a composite sustainability index (CSI), economic sustainability index (ESI), social sustainability index (SSI), and environmental sustainability index (EnSI) have been constructed. The study is motivated by the significant focus on wheat-rice monoculture in Punjab, which has led to declining agricultural growth, over-exploitation of groundwater, and excessive use of agro-chemicals, among other sustainability issues. The empirical results of CSI show that OF is more sustainable than CF in terms of environmental and social sustainability, whereas CF is economically more viable than OF. The study suggest that the government should adopt a balanced approach that encourages and promotes both farming systems simultaneously. To enhance the sustainability of CF, the focus should be on resource conservation technologies, farm practices and ensuring farmers’ well-being, while financial incentives, educational opportunities, and market expansion are crucial for making OF more sustainable.

A Composite Index for Sustainable Development: Measurement and Development Status of Selected Countries

Measuring and comparing development status among countries has long been a difficult task in economic analyses. Development analyses incorporating several aspects of sustainability are one of the most discussed concepts. The present study attempts to assess and measure the development status of various countries by developing a composite index for sustainable development. The measure comprises three sub-indices for economic, social, and environmental dimensions. For this purpose, separate sub-indices for economic, social, and environmental sustainability are designed and constructed to formulate a composite index for sustainable development. The study employs panel data to estimate the state of 140 countries for 1995-2020, taken from the World Bank. The sample includes 46 developed and 94 developing countries. The study utilized standard IMF index-construction methodology. The data is normalized by using the min-max method, and then the principal component analysis is applied for weighting selected variables. Finally, all weighted variables are aggregated to form up concerned indices. Selected countries were ranked based on their score obtained in all three dimensions and for the composite index. The study's findings highlighted high-income countries better in economic sustainability performance with greater environmental degradation. While low-income countries are also the lowest in economic sustainability, having lesser environmental damage. There are mixed results for social sustainability. The study recommends improvements in the economic and social dimensions of sustainability while maintaining environmental standards.

Is There Value in Large Cap Index Selection?

The rise of passive investing is shining a new light on the world of Indexing. Indexing is all around us today, whether being discussed by a media outlet showing the movements of the day or a newly launched passive ETF that tracks a recently created index. But there is little research on whether picking one index over another provides value to the investor when the indexes all share very similar index construction methodologies. Is there value in selecting one over the other or should investors choose the one that is the most accessible or cheapest to access? This article aims to fill that gap by conducting a comparative analysis of US Large Cap indexes that are substantially similar in their construction methodologies. As expected, the indexes selected perform very similar to one another based on the quantitative methods used within the analysis. Other than number of securities, the largest difference among the indexes is their exposure to Mid-Cap stocks. The decision of which index to select is dependent on the application being selected. This article focuses on the four purposes outlined by DiBartolomeo (2019) which are: journalistic, representation of an asset class, a fair benchmark, and basis of passive investment. In most cases, each index is a reasonable substitution for the others. Given that risk and return profiles are similar, factors such as number of securities, licensing costs, and brand value are the most significant to consider. This is especially true when selecting an index as the basis of a passive product, where those factors affect the product cost and capacity that can determine the success or failure of a passive product.

Tracking progress in meeting sustainable development goal 9 industry-related targets: An index for policy prioritization

The Green Economy Progress measurement methodology is used to construct a multidimensional composite index, the Sustainable Development Goal (SDG)-9 Progress Index, which measures the progress of countries in meeting the industry-related targets of SDG-9. The index differs from performance indicies in that it focuses on changes over time rather than levels of performance at points in time. Another feature of this index is that it shows the progress of countries in relation to their targets, which differ from country to country. The index is based on five indicators for the three industry-related targets of SDG-9, those where sufficient data are available: manufacturing value added (MVA) as a proportion of Gross Domestic Product, MVA per capita, manufacturing employment as a proportion of total employment, carbon dioxide (CO2) emissions per unit of MVA, and the proportion of medium and high-tech industry in MVA. Application of the SDG-9 Progress Index shows that out of 124 countries, 58 progressed towards their targets over the period 2000–2016 while 66 regressed away from them. No correspondence is found between the country rankings identified with the SDG-9 Progress Index and those identified with three performance indicies using the same or relatively similar CO2 indicators for index construction but different methodologies. An examination of the weighting specifications in the SDG-9 Progress Index for the CO 2 emission intensity indicator shows that improvements in this indicator for six out of the ten most progressive countries have the greatest potential among the five indicators for improving their rankings.

Törnqvist Formula for Сalculating a Consumer Price Index in Russia: Theory and Practice

The article reflects the author’s position on the adjustment of the so-called substitution bias, which affects the value of the consumer price index, currently calculated using the Laspeyres formula. The author proposes a solution to the problem of the adequacy of statistical measurements of the dynamics of consumer prices in the case when, as a result of changing cost of the consumer basket, a buyer replaces a relatively expensive product with a relatively cheaper one. This solution is based on the existing index construction methodology (axiomatic, economic and stochastic approaches). The article substantiates the use of the Törnqvist formula, which has better properties in comparison with other formulae used in the construction of superlative indices. The authors calculated the Törnqvist price index for Russia based on Rosstat methodology and data using country-level quarterly group price indices and shares of consumer spending. To evaluate the results of empirical testing Laspeyres price index was compiled using the same quarterly data as the Törnqvist index. The values of the Törnqvist price index in most cases are less than the price dynamics obtained according to the Laspeyres formula. This conclusion is proved both theoretically and empirically, and it is confirmed for Russia as well. However, due to the non-observance of the conditions of smooth trends in consumer prices, the difference between the values of the Törnqvist and Laspeyres indices is significantly larger in certain quarters than that presented in empirical studies in other countries. Consumer price index, calculated using the Törnqvist formula, in the system of indicators of price statistics in Russia can be defined as an indicator that specifies the main consumer price index. Calculation of its value is necessary for a more realistic description of the processes taking place in the consumer market.

A Better Way to Index: Revisiting and Revising a Central Tenet of Index Methodology

Most indexes are reconstituted periodically, typically quarterly or yearly, which induces high trading volume and significant trading costs for index funds. Here the authors propose a novel index reconstitution methodology that significantly reduces the trading volume and trading costs for funds tracking the index, without hurting the style purity of the index. The authors’ reconstitution methodology rebalances a small piece of the index every day, allowing index funds to use their daily cash flows to rebalance. Applying their reconstitution methodology to the Russell 2000, they find that the trading volume for funds tracking their proposed index is about 18% lower than that of funds tracking the current Russell 2000 Index. Further, funds tracking their index experience a 38% reduction in total trading costs, equivalent to 10 basis points of fund assets under management each year. Their methodology can be easily generalized and applied to most periodically reconstituted indexes and provides a solution to address the inefficiencies in current index methodologies. TOPICS:Mutual fund performance, exchange-traded funds and applications Key Findings • Indexes are reconstituted inefficiently, inflating transaction costs and reducing return for funds that track those indexes. • We propose a new index construction methodology that eliminates those inefficiencies and thus allows index mutual funds and ETFs to improve their returns without any sacrifice in style purity. • The improved returns from the use of this methodology are estimated to be substantial; for example, we estimate that a sample fund tracking the Russell 2000 Index using our new methodology would enjoy 10 bps of enhanced returns annually.

Exchange-Traded Confusion: How Industry Practices Undermine Product Comparisons in Exchange Traded Funds

Despite their incredible popularity and importance to modern capital markets, exchange traded funds (ETFs) are extremely difficult to compare side-by-side. Investors who successfully navigate the initial challenges of product choice overload, and opaque index construction methodology, soon encounter a wide array of discretionary operational, management, marketing, and financial practices of ETF sponsors that combine to undermine simple product and performance comparisons. This dilemma is compounded by disclosure effectiveness challenges given investor cognitive limitations and behavioral tendencies. This article is the first scholarly work, amongst a growing body of ETF studies, to illustrate why accurate “apples to apples� product comparisons in ETFs are so challenging (at times even impossible) to perform. It presents a variety of ETF case studies to demonstrate this challenge including recent performance instabilities in the coronavirus pandemic. It advocates for continued positive momentum around investor-focused reforms in ETFs, building on encouraging steps undertaken by the U.S. Securities & Exchange Commission in its recent “Rule 6c-11� under the Investment Company Act of 1940. It makes several recommendations to improve ETF product comparisons including standardizing website formats and layouts for information presentation, uniform calculation methodologies of key ETF variables, an ETF naming convention, and standard terms in sustainable investing. ETF investors would also greatly benefit from a systematized and structured electronic reporting mechanism whereby standardized data is provided by ETF sponsors to a centrally controlled public repository. Additional studies are warranted on strategic ETF disclosure ordering, digital enhancement, and added contextual discussion around critical concepts like arbitrage and index composition methodology. The ETF “model portfolio� industry is also an emerging concern that should be assessed, and the article provides suggestions to reduce informational opacity and improve comparative assessments.

Revisiting Index Methodology for Thinly Traded Stock Market. Case: Helsinki Stock Exchange

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.

Degradation index construction methodology for mechanical transmission based on fusion of multispectral oil data

PurposeThe purpose of constructing a degradation index (DI) is to better characterize the degradation degree of mechanical transmission compared with relying solely on spectral oil data, which leads to an accurate estimation of the failure time when the transmission no longer fulfills its function.Design/methodology/approachThe DI is modeled using a weighted average function with two desirable properties: maximizing the monotonic trend and minimizing the variance of failure threshold between different transmissions. The method includes concentration modification, data selection and data fusion steps that lead to a reasonable mechanical transmission degradation model. The proposed methodology was verified through a case study involving multispectral oil data sampled from several power-shift steering transmissions.FindingsThe results show that the DI outperforms all spectral oil data. Compared with the existing spectral oil data-based degradation modeling approach for mechanical transmissions, the present methodology provides an accurate RUL prediction.Research limitations/implicationsThere are several important directions for future research: First, more degradation data (i.e. ferrography) that are tailored to the degradation modeling of mechanical transmission need to be involved. Second, more effective degradation data selection methodologies that are applicable for multiple data types need to be developed. Third, kernel methods that can fuse the nonlinear degradation data need to be investigated.Originality/valueThe novelty of this methodology lies in integrating the multiple degradation data in a unified DI. And the main contribution of this paper is to establish a new direction in degradation modeling and RUL prediction of mechanical transmission.

The Creation and Benchmarking of a Green Municipal Bond Index

As the green bond market grows, many are wondering if there is a pricing difference between green bonds and conventional bonds. In order to explore these ideas, we created bond indices specific to the green-labelled and climate-aligned municipal bond market, primarily to test the competitiveness of the green sector of the muni bond market against the overall muni bond market. We used the S&P municipal bond index construction methodology in order to compare like with like, and benchmarked the green and climate indices against their counterpart S&P municipal indices. We find that the green and climate muni indices showed CAGRs of 4.5% from 2014 to 2017, compared with 3% for the S&P Investment Grade Municipal index. We also created several sector and state sub-indices, which also outperformed their S&P counterparts.

Hedge fund index-engineering methodologies: a comparison and demonstration

ABSTRACTWe examine hedge fund (HF) index construction methodologies, by describing and analysing case studies from two well-known database vendors and evaluating them using numerical examples on the same dataset. Despite the fact that they follow a similar due diligence process, there are great differences in the index engineering practices arising from different quantitative techniques, even for indices in the same HF category. However, those quantitative techniques provide similar results. The differences are rather due to the use of different HF universes and different inclusion criteria. This article is the first to use actual numerical case studies to illustrate and compare how HF index engineering works. Having read it, the reader will have a good understanding of how HF indices are formed.

Does Temporal Aggregation Explain the Persistence of the S&P/Case‐Shiller Indices? Evidence from a Longitudinal Specification

AbstractTemporal aggregation is a repeat sale index construction methodology that consists of aggregating paired‐transactions in a moving‐average window. In particular, the methodology is used to calculate the popular S&P/Case‐Shiller home price indices. In this article, I focus the insights of the literature on measurement error to demonstrate that temporal aggregation produces idiosyncratic biases in predictive regression slopes. I further estimate a dynamic instrumental variable (IV) panel for the 20 S&P/Case‐Shiller metro areas. The main empirical finding is that temporal aggregation is a short‐lived statistical disturbance that does not explain the homogenous robust persistence of the indices.

Alternative Beta Strategies

Market capitalization weighted indices have historically been the most widely used strategies to achieve a passive exposure to equities markets, or capture equities beta. However, we have seen a surge of strategies called alternative betas (or sometimes “smart betas”) that, using different index construction methodologies, aim to provide a passive exposure to alternative sources of equity returns, or equity factors. This paper begins by reviewing the existing index construction methodologies used to achieve equity market beta exposure, and then turns to analyzing alternative beta strategies that aim to provide exposure to Value, Momentum, Low Volatility, and Quality as alternative sources of equity risk premia in a passive, index-like way.

Momentum and Contrarian Stock-Market Indices

We propose a new class of investable momentum and contrarian stock-market indices that partition a benchmark index, such as the Russell 1000. Our momentum indices overweight stocks that have recently outperformed, while our contrarian indices underweight these same stocks. Our index construction methodology is extremely flexible, and allows the index provider to trade-off the distinctiveness of the momentum/contrarian strategies with portfolio turnover. Momentum investment styles in particular typically entail a high level of turnover, and hence high associated transaction costs. The creation of momentum and contrarian indices and exchange traded funds (ETFs) based on our methodology would allow investors to access these styles at lower cost than is currently possible. Our indices also provide performance benchmarks for momentum/contrarian investment managers, and good proxies for a momentum factor. Over the period 1995-2007 we find that short term momentum and long term contrarian indices outperform the reference Russell 1000 index. We also document the changing interaction between the momentum/contrarian and value/growth styles.

Issues in Hedge Fund Index Engineering: A Comparison and Demonstration

We examine hedge fund index construction methodologies, by describing and analysing the general principles and construction methods for a successful hedge fund index. We present case studies from two well-known database vendors and evaluate them using numerical examples on the same dataset. Despite the fact that they follow a similar due diligence process, there are great differences in the index engineering practices arising from different quantitative techniques, even for indices in the same hedge fund category. However, those quantitative techniques provide similar results. The differences are rather due to the use of different hedge fund universes and different inclusion criteria. This paper is the first to use actual numerical case studies to illustrate and compare how hedge fund index engineering works. Having read it the reader will have a good understanding of how hedge fund indices are formed and current issues in the area.

Comparing Economic Developments in the Greater China through Building Chinese Consumer Confidence Indexes

Chinese consumer confidence index is the first combined confidence index for four related economies (Mainland China, Hong Kong, Macau and Taiwan) calculated through the same survey and construction methods. It enables both vertical and lateral comparisons among these economies. This paper illustrates the index construction methodology and tests how the index values vary for different consumer types, e.g. gender, income, age and education. The abilities of the indexes to compare economic development, reflect consumer expectations and satisfaction attitudes and forecast the state of the economy are also tested with the first-hand data for more than twenty quarters, collected through longitudinal surveys. The ability to predict expectations for lagged satisfaction is confirmed through regression analysis, which makes the index values reliable. The index's ability to forecast macroeconomic development is verified by Granger causality tests between the index values and the corresponding macroeconomic indicators. The index can assist governments in locating, summarizing and analyzing existing economic problems and help industries and consumers make more informed economic decisions. It can also be used as a leading indicator for some aspects of economic developments.

A new approach for constructing home price indices: The pseudo repeat sales model and its application in China

This paper develops a “pseudo repeat sale” estimation sample construction procedure (ps-RS) to construct more reliable and less biased quality-controlled price indices for newly-constructed homes. The method may be useful wherever new housing development is of sufficiently large scale and homogeneous. Such circumstances characterize many emerging market countries, and here we apply the technique in China. We match two very similar new sales within a defined matching space. Here we test three versions of matching spaces – complex, phase, and building. We then regress the within-pair price differentials onto time dummies and the differentials in unit-specific physical attributes. Locational and community variations, as well as many unobservable or difficult to measure physical attribute variations, are cancelled out in the model, and thereby controlled for. The building-version ps-RS index does the best job in this regard because its within-pair differential is the smallest. We further introduce a “hedonic value” distance metric criterion so that one can deal flexibly with the trade-off between the within-pair “similarity” and the sample size. We explicate and demonstrate formal signal-to-noise oriented metrics of index quality, which can be superior to traditional standard errors based metrics, and we use the new metrics to compare index construction methodologies. The ps-RS approach addresses the problem of lack of repeat-sales data in emerging markets and newly constructed properties and the omitted variables problem in the hedonic method. It also addresses the traditional problems with the classical same-property repeat-sales model in terms of small sample sizes and sample selection bias.The present paper tests the ps-RS method using a large-scale micro transaction data set of new home sales from January 2006 to June 2011 (444,596 observations) in Chengdu, Sichuan Province, China. The resulting complex-based ps-RS index essentially parallels the hedonic index, suggesting that the hedonic index is not superior to that version of the ps-RS index in terms of systematic results. The phase-based ps-RS index has a lower growth trend and the building-based version lower still, indicating omitted variables relating to the physical quality of the units are not well controlled for in the hedonic, and suggesting that the building-based version of the ps-RS index provides the greatest control for such quality differences. Building-based ps-RS indices with different distance metric thresholds are almost the same. Compared to the hedonic, the ps-RS provides a smoother index indicating less random estimation error (or “noise”).

A comparison between capitalization-weighted and equally weighted indexes in the European equity market

This article aims at comparing two major equity index construction methodologies, the capitalization-weighted and the equally weighted approaches. Focusing on the constituents of the DJ Euro Stoxx index from January 2002 to December 2011, it provides further evidence to add to the established literature on this topic, of the higher risk-adjusted returns achieved by equally weighted portfolios in comparison with cap-weighted indexes. The novelty of our study is that we test these findings on the Euro stock market by using four reweighting frequencies (monthly, quarterly, semiannually and annually) with the aim of identifying that which is most able to maximize the benefits of the contrarian strategy implicit in the equally weighted approach. Moreover, it is demonstrated that the excess returns are not driven solely by a ‘size effect’ that usually explains the difference in performance of the two methodologies. Finally, we confirm our results by performing a Fama-French (1992) three-factor regression analysis and also by using a portfolio approach based on the market capitalization of the index constituents. To evaluate the implementation of the EW strategy, from an operational perspective, we estimate the related transaction costs and show that trading costs are not able to affect the main results.

Implications of Index Construction Methodologies for Price and Dividend Indices

Investment products tracking the performance of equity indices have become irreplaceable in the investment community. We are the first to analyze the impact of index replacements and the choice of indexing methodologies on relative performance, using one consistent approach for price indices and dividend indices, which have recently been developed. We implement an empirical case study as well as an extensive simulation study incorporating mean reversion and momentum in the process for price-to-dividend ratios. Calibrating our model to capital market dynamics, we find that periodically rebalanced market capitalization weighted indices are outperformed by buy-and-hold portfolios and also by fundamentally weighted indices. Rebalancing affects dividend indices more adversely than price indices. We highlight sensitivities of performance dispersion between different index methodologies by varying mean reversion and momentum parameters. Mean reversion dominates momentum as driving force in our setup. We identify index size, rebalancing frequency and criteria applied to assign weights as key variables affecting the relative performance of price and dividend indices. As a consequence, choosing an index methodology can be considered as an active strategy.