Risk-Based Indexation

Abstract

A capitalization-weighted index is the most common way to gain access to broad equity market performance. These portfolios are generally concentrated in a few stocks and present some lack of diversification. In order to avoid this drawback or to simply diversify market exposure, alternative indexation methods have recently prompted great interest, both from academic researchers and market practitioners. Fundamental indexation computes weights with regard to economic measures, while risk-based indexation focuses on risk and diversification criteria. This paper describes risk-based indexation methodologies, highlights potential practical issues when implemented, and illustrates these issues as it applies to the Euro Stoxx 50 universe.

Keywords: Risk-Based Indexation, Fundamental Indexation, Market Capitalization, Equity Indexes, Diversification, Portfolio Optimization, Robust Estimation

JEL Classification: G11, C60