Efficiency-based index tracking optimization model

Efficiency-based index tracking optimization model

• Author
• Eduardo Tondo Pian
• Co-authors
• Leonardo Riegel Sant Anna
• Abstract

• We used asset efficiency as an approach for portfolio selection in a classical index tracking (IT) optimization model. The stock efficiency levels are measured based on the Multifractal-Detrended Fluctuation Analysis (MF-DFA). We form portfolios that seek to replicate the S&P500, the Nikkei 225 and the Ibovespa index, such that our empirical analysis covers three financial markets worldwide (US, Japan and Brazil), using daily stock returns from 2012 to 2021. Our results indicate that using efficiency as a way of selecting the components for tracking portfolios provides good solutions when compared to portfolios without constraint on their size, as well as when compared to another study that was based on a robust numerical approach (a metaheuristic defined as genetic algorithm) to solve the IT problem. We evidenced that using efficiency as a way to form tracking portfolios is an interesting alternative to reduce the number of stocks in the porrtfolios without the need to design a robust methodology to solve the IT optimization especially in developed markets, in which case where the overall level of efficiency tends to be larger (such as US and Japan).

• Keywords
• Index tracking, Portfolio optimization, Stock efficiency
• Subject Area
• Asset pricing, investments, and Derivatives

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