Stock Market Indices

A number of stock indices are constructed in India. RBI Share Price Index, BSE National Index, CMIE Index, CRISIL Index, BSE 200 Index, SENSEX, S & P CNX, Nifty index. Dollex, ET Index, PE Index, and so on. The more popular ones are described below:

Bombay Stock Exchange Sensitive Index: Perhaps the most widely followed stock market index in India, the Bombay Stock Exchange Sensitive Index, popularly called the Sensex reflects the movements of 30 sensitive shares from specified and non-specified groups. The index for any trading may reflect the aggregate market value of the sample of 30 shares on that day in relation the average aggregate market value of these shares in the base year 1978-79. This means that this is a value weighted index.

From September 1, 2003 Sensex is being constructed on the basis of free float market cap rather than full market cap. Free float market cap is the market value of free float the portion of the shares issued by the company that are readily available for trading in the market. To get the free float, promoter holdings, government holdings, and locked-in shares are excluded from the total shares issued by the company. This change has been effected to conform to the best global practice.

S&P CNX Nifty: Arguably the most rigorously constructed stock market index in India, the Nifty Index reflects the price movement of 50 stocks selected on the basis of market cap and liquidity (impact cost). The base period selected for Nifty Index is the close of price on November 3, 1995 whcih marked the completion of one year of operation of NSE’s capital Market Segment. The base value of the index has been set at 1000. It is a value weighted index.

The Economics Times Index of Ordinary Share Prices: On trading days, The Economic Times publishes the all India index of ordinary share prices. The base year for this index is the financial year 1984-85, the sample used for his index consists of 72 actively traded shares, and the average employed in the construction of this index is a simple arithmetic of price relatives. This means that this is an equal weighted index.

The Financial Express Equity Index: Published by The financial Express, this index has the calendar years 1979 as the base year, is based on 100 actively traded shares, and employs a weighted arithmetic average of the price relatives of the share in the sample. This means that this is a value-weighted index.

Bombay Stock Exchange National Index: A broad-based index in comparison to the Sensex, the Bombay Stock Exchange National Index reflects the price movement of 100 actively traded shares drawn from specified and non-specified groups of the five major stock exchanges namely, Bombay, Calcutta, Delhi, Ahmedabad, and Madras The base year for this index is 1983 and it is calculated in a way identical to that of the Sensex. This means that this too is a value weighted index.

Issues in Constructing the Index:

The important issues in constructing a stock market index are: Are indices based on samples reliable? What is the tradeoff between diversification and liquidity? Should we use a value weighted index like the Sensex or an equal weighted index like the ET Index of Ordinary Share Prices? What is the trade off between diversification and liquidity?

Reliability: Indices based on samples (even when samples are as small as 30) are fairly reliable because of the tendency of all stocks to move together. When the purpose of an index is to represent the changes in the values of stocks, one can have great confidence in a small sample of large companies because relatively few companies account for a large proportion of the value of all companies.

Trade off: Diversifying the index reduces risk, but at a diminishing rate. Increasing the sample size from 10 stocks to 20 stocks reduces risk sharply, but going from 50 stocks to 100 stocks brings only a marginal reduction in risk. While risk reduction benefit diminishes, a serious problem arises if illiquid stocks have to be included. Since prices of such illiquid stocks are contaminated they may worsen the quality of the index. Hence constructing a good index involves a tradeoff between the quality of the index. Hence, constructing a good index involves a tradeoff between diversification and liquidity.