Index Tracking In Portfolio Optimization With Tracking Error Variance Model

Volume 1, Issue 2, December 2016     |     PP. 16-24      |     PDF (182 K)    |     Pub. Date: December 21, 2016
DOI:    376 Downloads     7162 Views  

Author(s)

Lam Weng Siew, Department of Physical and Mathematical Science, Faculty of Science, Universiti Tunku Abdul Rahman, Kampar, Perak, Malaysia; Centre for Mathematical Sciences, Centre for Business and Management, Universiti Tunku Abdul Rahman, Kampar, Perak, Malaysia
Lam Weng Hoe, Department of Physical and Mathematical Science, Faculty of Science, Universiti Tunku Abdul Rahman, Kampar, Perak, Malaysia; Centre for Mathematical Sciences, Centre for Business and Management, Universiti Tunku Abdul Rahman, Kampar, Perak, Malaysia

Abstract
Index tracking is a form of portfolio management in stock market investment. Index tracking aims to track the performance of the stock market index without purchasing all the stocks that make up the market index in order to achieve rate of return similar to the market return. This objective can be achieved by determining an optimal portfolio which minimizes the tracking error of the optimal portfolio to the benchmark market index. Tracking error is a risk measure of how closely a portfolio follows the benchmark index. The objective of this study is to determine the optimal portfolio composition by using tracking error variance (TEV) model in index tracking. The results of this study show that the optimal portfolio of TEV model is able to track the Malaysia market index which is FTSE Bursa Malaysia Kuala Lumpur Composite Index effectively with only holding 40% of the component stocks in the market index.

Keywords
Index Tracking, Tracking Error Variance Model, Mean Return, Portfolio Composition

Cite this paper
Lam Weng Siew, Lam Weng Hoe, Index Tracking In Portfolio Optimization With Tracking Error Variance Model , SCIREA Journal of Economics. Volume 1, Issue 2, December 2016 | PP. 16-24.

References

[ 1 ] Treynor, J. and Black, F., 1973. How to Use Security Analysis to Improve Portfolio Selection. Journal of Business 46 (9): 66-86.
[ 2 ] Beasley, J. E., Meade, N. and Chang, T. J., 2003. An evolutionary heuristics for the index tracking problem. European Journal of Operational Research, 148: 621-643.
[ 3 ] Roll, R., 1992. A Mean Variance Analysis of Tracking Error. The Journal of Portfolio Management, 18(1): 13-22.
[ 4 ] Canakgoz, N. A. and Beasley, J. E., 2008. Mixed integer programming approaches for index tracking and enhanced indexation. European Journal of Operational Research, 196: 384-399.
[ 5 ] Guastaroba, G. and Speranza, M. G., 2012. Kernel Search: An application to index tracking problem. European Journal of Operational Research: 217, 54-68.
[ 6 ] Lam, W. S. and Lam, W. H., 2015. Portfolio Selection for Index Tracking Problem in Malaysian Stock Market. International Journal of Administration and Governance, 1(3): 15-17.
[ 7 ] Lam, W. S., Saiful, J. and Hamizun, I., 2014. Comparison between Two Stage Regression Model and Variance Model in Portfolio Optimization. Journal of Applied Science and Agriculture, 9(18): 36-40.
[ 8 ] Lam, W. S., Saiful, J. and Hamizun, I., 2014. Index Tracking Modelling in Portfolio Optimization with Mixed Integer Linear Programming. Journal of Applied Science and Agriculture, 9(18): 47-50.
[ 9 ] Lam, W. S., Saiful, J. and Hamizun, I., 2015. The impact of human behavior towards portfolio selection in Malaysia. Procedia of Social and Behavioral Sciences, 172: 674-678.
[ 10 ] Lam, W. S., Saiful, J. and Hamizun, I., 2015. Investigation on relationship between human behavior and portfolio selection problem in Malaysia, Advances in Environmental Biology, 9(7): 6-10.
[ 11 ] Lam, W. S., Saiful, J. and Hamizun, I., 2015. An empirical study on the characteristics on high risk aversion behavior in portfolio decision making, Advances in Environmental Biology, 9(7): 17-20.
[ 12 ] Lam, W. S. and Lam, W. H., 2016. Mathematical modeling in enhanced index tracking with optimization model. Journal of Numerical Analysis and Applied Mathematics, 1(1): 1-5.
[ 13 ] Wu, L. C., Chou, S. C., Yang, C. C. and Ong, C. S., 2007. Enhanced Index Investing Based on Goal Programming. The Journal of Portfolio Management, 33: 49-56.
[ 14 ] Markowitz, H., 1952. Portfolio Selection. Journal of Finance, 7: 77-91.
[ 15 ] Fabozzi, F. J., and Francis, J. C., 1979. Mutual Fund Systematic Risk for Bull and Bear Markets: An Empirical Examination. Journal of Finance, 34: 1243-1250.
[ 16 ] Meade, N. and Salkin, G. R., 1990. Developing and Maintaining an Equity Index Fund. Journal of Operation Research Society, 41(7): 599-607.
[ 17 ] Bodie, Z., Kane, A. and Marcus, A. J., 2008. Investments. 7th Edition. New York: McGraw-Hill.