Benchmark Concentration: Capitalization Weights versus Equal Weights in the FTSE 100 Index

Abstract

Identifying a suitable benchmark is essential when testing asset pricing models, measuring the performance of active investors, or providing market proxy portfolios for passive investors. Concern that increased domination of capitalization weighted stock indices by a few large firms will lead to inefficient portfolio diversification is leading some investors and researchers to argue that index providers should adjust their weighting methods to limit concentration. This study tests and rejects the hypothesis that concentration arising as a result of capitalization weights in the FTSE 100 Index increases risk, either during normal market conditions or during negative tail events in the return distribution.

Keywords: stock index benchmarks; incremental returns; incremental standard deviation; portfolio diversification; capitalization weights; index concentration; performance measurement

JEL Classification: G11, G12, G14