Methods of constructing a stock market index

[warakawa]

1. equal weighting
2. value weighting and
3. price weighting

what are the advantages of each methods and which is the most accurate.

 

[noie]

Man this reminds me of one of my University questions...

wait it is one of my university questions..

when i answered it i used this site

How Stock Indices Work

which took me to :

http://www.wikinvest.com/wiki/How_Stock_Indices_Work

 

[howardbandy]

Greetings --

Those links and other Internet searches will give you explanations of the methods.

If you are planning to construct indexes for your own use, be aware of the "survivorship bias" that occurs when an index is created using the current list of constituents.

If I want an index that mimics the S&P 500, and I use the list of stocks that are in S&P 500 today, along with the price history for each of them, my custom index will remain in synchronization only back as far as the most recent reconstitution.

If you will be using indexes in a trading system, there is an advantage in using indexes maintained by some agency -- a mutual fund, an ETF, a financial services company, etc -- who kept it up-to-date on a regular basis over the history of the index using the then-current membership list.

Thanks,
Howard