Index tracking with utility enhanced weighting

Clark, Ephraim A., Deshmukh, Nitin ORCID:, Güran, Celal Barkan and Kassimatis, Konstantinos (2019) Index tracking with utility enhanced weighting. Quantitative Finance, 19 (11) . pp. 1893-1904. ISSN 1469-7688 (Published online first) (doi:10.1080/14697688.2019.1605189)

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Passive index investing involves investing in a fund that replicates a market index. Enhanced indexation uses the returns of an index as a reference point and aims at outperforming this index. The motivation behind enhanced indexing is that the indices and portfolios available to academics and practitioners for asset pricing and benchmarking are generally inefficient and, thus, susceptible to enhancement. In this paper we propose a novel technique based on the concept of cumulative utility area ratios and the Analytic Hierarchy Process (AHP) to construct enhanced indices from the DJIA and S&P500. Four main conclusions are forthcoming. First, the technique, called the utility enhanced tracking technique (UETT), is computationally parsimonious and applicable for all return distributions. Second, if desired, cardinality constraints are simple and computationally parsimonious. Third, the technique requires only infrequent rebalancing, monthly at the most. Finally, the UETT portfolios generate consistently higher out-of-sample utility profiles and after-cost returns for the fully enhanced portfolios as well as for the enhanced portfolios adjusted for cardinality constraints. These results are robust to varying market conditions and a range of utility functions.

Item Type: Article
Research Areas: A. > Business School > Accounting and Finance
Item ID: 26368
Notes on copyright: This is an Accepted Manuscript of an article published by Taylor & Francis in Quantitative Finance on 11/06/2019, available online:
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Depositing User: Nitin Deshmukh
Date Deposited: 09 Apr 2019 07:33
Last Modified: 12 Jul 2020 07:22

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