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

Citation

Tabner I (2005) Benchmark Concentration: Capitalization Weights Versus Equal Weights in the FTSE 100 Index. SSRN Working Paper Series, 1026548. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1026548

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. On the contrary, during the left tail of the return distribution, the equally weighted portfolio of FTSE 100 Index constituents exhibits higher risk and lower returns than the capitalization weighted FTSE 100 Index portfolio, a finding consistent with variations of the CAPM that allow for time varying risk premia.

Keywords
Index Concentration; Benchmark Indexes; Portfolio Management; Performance Evaluation; Portfolio Theory

People

Dr Isaac Tabner

Senior Lecturer in Finance, Accounting & Finance