index tracking
Forgive my skepticism, but I doubt that any stocks are really cointegrated with an index. The cointegration approach might work, but I think you'd be finding highly correlated stocks. The traditional way (as far as I know) is to do an optimization that minimizes tracking error subject to the number-of- names constraint that you want. I do agree that daily rebalancing is almost surely overkill. Monthly rebalancing might even be as well. It is going to depend on the tracking error you can tolerate, and how important not breaking the tracking error bound is to you. Patrick Burns patrick at burns-stat.com +44 (0)20 8525 0696 http://www.burns-stat.com (home of "The R Inferno" and "A Guide for the Unwilling S User")
Adams, Zeno wrote:
I'm after suggestions for the design of simple index-tracking models.
I >>have access to good clean data, and I am trying to cook up portfolios >>which replicate indices with a minimum number of long positions when >>rebalancing is done daily. I think a nice way to replicate an index using only a few long positions is to use equities that are cointegrated with the index. An example is given in Carol Alexander's (2001) book: "Market Models. A Guide to Financial Data Analysis" Ch.12. This can be done in R using Paff's urca package. You may also want to look at his book "Analysis of Integrated and Cointegrated Time Series with R". If done correctly, you don't even have to rebalance on a daily basis. Zeno EBS European Business School gemeinnuetzige GmbH - Sitz der Gesellschaft: Wiesbaden, Amtsgericht Wiesbaden HRB 19951 - Umsatzsteuer-ID DE 113891213 Geschaeftsfuehrer: Prof. Dr. Christopher Jahns, Praesident; Prof. Dr. Rolf Tilmes, Dekan; Sabine Fuchs, CMO; Aufsichtsrat: Dr. Hellmut K. Albrecht, Vorsitzender
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