Rebalancing

[archived_user]

Q. Which of the following index weighting method requires most frequent rebalancing?
a. Price Weighting
b. Equal weighting
c. Market-cap weighting
OA is B
I chose A because fluctuating prices will require constant adjustment of weights. I would have expected B to to have least rebalancing. Can someone please help me?

 

[archived_user]

Price-weighted indices need to be rebalanced when:

• A stock split occurs
• A reverse stock split occurs
• A stock dividend is issued
• One stock is replaced with another stock

Cap-weighted indices need to be rebalanced when:

• One stock is replaced with another stock

Equal-weighted need to be rebalanced when:

• Any one stock’s return is different from any other stock’s return

Price-weighted indices are rebalanced almost never.
Cap-weighted indices are rebalanced less than almost never.
Equal-weighted indices are usually rebalanced daily.
I wrote an article on equity indices that goes into this in detail: http://www.financialexamhelp123.com/equity-indices/.
(Full disclosure: as of 4/25/16 there is a charge for viewing the articles on my website. You can view sample articles for free (to get an idea of the quality of the articles) here: http://www.financialexamhelp123.com/sample-articles/.)

 

[archived_user]

Most equal-weighted indices I know that are available in the market as ETFs don’t rebalance daily, mostly quarterly. That’s mostly from a practical point of view though (theoretically it would have to be rebalanced daily in order to achieve equal weights at all times).
That isn’t done in practice because equal-weighted indices profit from mean reversion in stock prices, a sort of rebalancing return. This contributes to the favorable risk-return profile of such an index (in gross terms). Not allowing stocks to deviate from their initial weights (by rebalancing daily) forgoes the rebalancing return and would lead to excessive transaction costs.

 

[archived_user]

Moonborne wrote: Most equal-weighted indices I know that are available in the market as ETFs don’t rebalance daily, mostly quarterly.

I was talking about the indices themselves (which rebalance daily), not about funds that try to mimic those indices.