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A methodology proposal for stock selection in index tracking
Ismael Moya and Francisco Guijarro |
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This paper presents a methodology that performs index tracking using a reduced number of assets. Opposite to other heuristic approaches, our proposal is able to unambiguously determine the number of assets to be considered in the tracking portfolio through a process that implements three consecutive steps, which facilitates its automation by portfolio managers. The principal components analysis enables assets to differently explain the variability in the index return; that is, it makes incremental value relevance of individual assets to be as important as possible, minimizing the overlapped information reported in the model.
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