Sat, Nov 18, 2017
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Industry Updates

EDHEC-Risk study finds no theoretical or empirical justification for cap-weighted indices

Tuesday, June 29, 2010
Opalesque Industry Update - After the financial crisis and the accompanying falls in the stock markets, many commentators have questioned the appropriateness of tracking cap-weighted indices. These indices are particularly inefficient and, through their momentum properties, favour the emergence of speculative bubbles.

New research from the EDHEC-Risk Institute shows that financial theory, despite widely-held views to the contrary, does not support investment in these types of indices. It is therefore urgent for investors to seek alternatives to these indices which are justified by neither fact nor theory.

The three main conclusions of the research are the following:

1.A cap-weighted stock market index is not the market portfolio of financial theory (the Capital Asset Pricing Model (CAPM) theory is often evoked to show that cap-weighted stock market indices are efficient portfolios and attractive investments). That it is not is clear from the choices made in empirical studies that attempt to come up with reasonable proxies for the market portfolio. These studies attach great importance to including many more stocks than indices do, and their proxies of the market portfolio include bonds, real estate, and non-tradable assets such as human capital.

2.Even if it were possible to construct and hold the market portfolio, the theory does not predict that the market portfolio is efficient unless we make highly unrealistic assumptions. In fact, the authors of the seminal academic research in the 1950s and 1960s, Harry Markowitz and William Sharpe, have themselves emphasised (Sharpe (1991) and Markowitz (2005)) that the market portfolio may not be efficient in a more realistic setting.

3.In view of these arguments, financial theory alone does not justify the current practice of cap-weighting. In fact, from a theoretical perspective, cap-weighted stock market indices seem to offer no particular advantage.

The EDHEC-Risk Institute Publication, “Does Finance Theory Make the Case for Capitalisation-Weighted Indexing?” can be downloaded by pressing [Ctrl] and clicking on the following link: Source

- FG

What do you think?

   Use "anonymous" as my name    |   Alert me via email on new comments   |   
Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing

 



  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. Middle East - Saudi-Iran war would create this domino effect of global disaster, Saudi billionaires said to move funds from region to escape asset freeze[more]

    Saudi-Iran war would create this domino effect of global disaster From CNBC.com: Events appear to be spinning out of control in the Middle East, and the threat a Saudi-Iranian war is looking increasingly credible. Make no mistake, an out and out conflict between the two nations would be

  2. Paradise Papers - Robert Mercer's effort to avoid taxes appears in Paradise Papers, Tycoon made $41m from 'people's fund', Oxford and Cambridge 'investing millions of pounds offshore', Paradise Papers reveal[more]

    Robert Mercer's effort to avoid taxes appears in Paradise Papers From Therealnews.com: The Guardian has reported that conservative billionaire and Trump backer Robert Mercer "appears as a director of eight Bermuda companies in the Paradise Papers," the trove of documents reviewed by the

  3. Wall Street hedge fund veteran hits highs with copycat tactics[more]

    From FNLondon.com: A Wall Street veteran who has made big returns for wealthy clients by piggybacking on the strategies of well-known hedge funds is taking his novel approach to stock-picking to institutional clients. Dixon Boardman, chief executive of $2.5bn fund of hedge funds Optima Fund Ma

  4. Launches - Eaton Vance, Oaktree to launch diversified credit NextShares fund, FIM launches Nordic AI-powered fund[more]

    Eaton Vance, Oaktree to launch diversified credit NextShares fund Eaton Vance Management, a subsidiary of Eaton Vance Corp., announced the expected mid-November launch of Eaton Vance Oaktree Diversified Credit NextShares, a new Eaton Vance-sponsored exchange-traded managed fund. Eaton Va

  5. Outlook - Gundlach's stock market warning comes true[more]

    From Bloomberg.com: Jeffrey Gundlach has been warning something's got to give. Based on the past two days, looks like we have our answer. Stocks fell around the world a second day and high-yield bonds headed for a fourth straight loss, resuming a historic correlation that the hedge fund manager on W