In Defence of Capitalisation Weights: Evidence from the FTSE 100 and S&P 500 Indices

Citation

Tabner I (2011) In Defence of Capitalisation Weights: Evidence from the FTSE 100 and S&P 500 Indices. SSRN Working Paper Series, 1977735. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1977735

Abstract
A simple method for decomposing the variance covariance matrix of portfolio returns at the level of individual stocks is applied to the FTSE 100 Index. During extreme negative shocks, the largest index constituents exhibit lower than average covariance, thereby reducing the volatility of the capitalisation-weighted index. The risk-adjusted returns of the capitalisation-weighted FTSE 100 Index exceed those of an equally‐weighted version of the same index and the outperformance is robust to the method of risk adjustment applied. The equally-weighted index also exhibits greater systematic (market) risk than the capitalisation-weighted version.

Keywords
FTSE 100 Index; S&P 500 Index; benchmark portfolios; capitalisation weights; stock indices; portfolio diversification; performance measurement