Applying Time Series Decomposition to Construct Index-Tracking Portfolio

Jun Nakayama () and Daisuke Yokouchi ()
Additional contact information
Jun Nakayama: Hitotsubashi University Business School
Daisuke Yokouchi: Hitotsubashi University Business School

Asia-Pacific Financial Markets, 2018, vol. 25, issue 4, No 4, 352 pages

Abstract: Abstract This study proposes a new method for creating an index-tracking portfolio using time series decomposition. First, we construct index-tracking portfolios of stocks chosen because their price movements mimic that of the Dow-Jones Industrial Average. Our method utilizes similarities of constituent stocks to the benchmark that are assessed by distances of time series trends derived from decomposing original series. Although the portfolios chosen by our method reasonably tracked the performance of the benchmark, they did not surpass the clustering approach discussed in earlier studies. Therefore, we examined what causes tracking error and found that two causes for deficiencies in our similarity-based method, which are unintended irregular movements of holding stocks and highly correlated relationships within stocks in the portfolio. To overcome them and to improve tracking performance, we propose a similarity-balanced approach that is another index-tracking method with alternate use of similarity. Doing so improved the tracking performance by avoiding the problem of high correlation among the stocks chosen under the initial method.

Keywords: Hierarchical clustering; Index-tracking; Locally weighted regression; Lowess; Portfolio management; Time series decomposition (search for similar items in EconPapers)
JEL-codes: G11 G23 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s10690-018-9252-7 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:apfinm:v:25:y:2018:i:4:d:10.1007_s10690-018-9252-7

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/10690/PS2

DOI: 10.1007/s10690-018-9252-7

Access Statistics for this article

Asia-Pacific Financial Markets is currently edited by Jiro Akahori

More articles in Asia-Pacific Financial Markets from Springer, Japanese Association of Financial Economics and Engineering
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().