Risk weighted alpha index – analysis of the ASX50 index

Abstract

Major stock indexes are developed on the market capitalization or price weighted indexation method. The Australian Stock Exchange 50 (ASX50) index is a market capitalization index of the top 50 Australian stocks. Fundamental indexation, equal weighted index and risk weighted index methods have recently been developed as an alternative to the market cap and price indexes. However, empirical studies do not conclusively prove if these alternate methods are more efficient to the existing market cap or price weighted methods. Also, the fundamental index method provides a higher alpha, while the risk weighted index methods focus on risk reduction through diversification. There is a gap to develop another passive indexation method in order to provide the investor a higher return (alpha) and lower volatility. This paper re-weights the ASX50 index using the risk weighted alpha method and provides higher weight to stocks that have increasing returns and lower volatility. The empirical study for ASX50 index from 2002-2012 is undertaken and results show that the risk weighted alpha method provides higher return and has lower systematic risk than the ASX50 index.