I am arbitraging between index and the stocks which constitutes the index. whenever i find that index futures is over/underpriced..i short/long the future and take the reverse position in the stocks constituting the index .But since all the stocks constituting the index are not available in futures segment i was incurring some slippage cost which might turn up into loss. Is ther any aother method of emulating the index apart from taking positins in all the stocks. Maybe by varying the weights in few stocks an index can be emulated with acceptable level of tracking error.Someone plis enlighten on how to approach the problem.Apart from the above mentioned problem I also have some academic interest also to know whetehr any research work has been done in this field, whereby an index is being emulated with fewer no. of stocks.And if so what is the result ?
What do you mean by "all the stocks constituting the index are not available in futures segment" ? Thanks, Chinook
what i mean is that in few emerging markets all the stocks are not available for trading in futures segment. That is why if i take position in index i cant take reverse position in all the stocks constituting the index ( due to the unavailability of few of them in futures segment) .This creates a situation where my index position is not totally covered up by my individual stock positions. Hope this clarifies ur doubt.
Maybe you can emulate it by only tarding stocks with the highest weight. For instance instead off emulatin it 100% you can only use stocks which approximates the index 75-80% (this'll probably be less than %50 of the total number of stocks). Chinook
Is there any research work in this field where in the line of optimum portfolio management theory..there is an optimum portfolio which will follow the index most accurately? I think there should be some research work in the field of variance minimization..where the variance of the index tracking portfolio is minimized by rebalancing it at reguar intervals...someone plis thorw some light..