Building stock market indices according to different weighting schemes

Abstract

We hear a lot about what's happening to the Dow Jones Industrial Average (DJIA) every day. And you probably do
Also about other stock indices such as the S&P 500 index, the Nasdaq Composite index, the Nikkei index, or even the Saudi stock index. If you listen carefully, you will realize that these indices experience different relative changes (which is the way changes should be announced). The reasons for some differences are clear, but there are other reasons that are not clear. Therefore, in this paper we will review how the main indices differ in characteristics that help us understand why the relative changes of different indices should differ over time. We will organize the discussion of indices according to a stock sample weighting scheme. We will start with the price-weighted index because some of the most popular indices fall into this category. The next group is the value-weighted index, which is the method currently used for most indicators. Finally, we will examine the unweighted indicators. The research has reached a number of conclusions, the most important of which are two of the most important requirements for building stock market indices: an appropriate and representative sample, an appropriate and solid weighting scheme, as well as an accurate and clear mathematical method for calculating the value of the index. The value-weighted scheme is the best among other weighting schemes. The research also reached a number of recommendations, the most important of which is the need for the concerned authorities in the Iraq Stock Exchange to build a value-weighted index that adopts the modified weighting method and includes all stocks listed in the market. In addition to the necessity of building sectoral indicators weighted by value. Each of them contributes to reflecting the true general picture of the performance of companies operating in that sector, in addition to the comprehensive picture reflected by the comprehensive index. Especially since the market to this day talks in its bulletins about the “price index”!