What exactly is this all about? Passive investment funds such as ETFs (exchange-traded funds) aim to replicate an index such as the German stock index (DAX) as accurately as possible. If a stock investor buys an ETF, the value of their fund may deviate by 1.5 percent from the real DAX after one year. Why? Because the replication – the method by which an ETF replicates the performance of a particular stock index – was not perfect. Using a clever new mathematical trick, the academic study by Professor Christian Fieberg, Professor Armin Varmaz (Bremen City University of Applied Sciences, HSB), Dr. Carlos Osorio, and Professor Thorsten Poddig (University of Bremen) improves the accuracy of ETFs.
Why the Problem Is So Important
“Traditional methods are often prone to so-called ‘estimation errors’ – for example, because too many stocks are taken into account or because the data is inaccurate,” explains Professor Armin Varmaz. This leads to deviations that add up over the years and can cost investors money. An ETF that tracks the DAX should really reflect the DAX – not just approximate it. “Our approach uses characteristic features of companies – such as size, growth, and value – to make the selection of stocks more intelligent,” explains the academic.
The four researchers developed a novel optimization approach that is not only more precise but also controls the number of stocks in the fund. This ensures transparency and manageability. “We have shown that our model consistently performs better in all tests – from different indices over different time periods to different transaction costs,” emphasizes Professor Christian Fieberg (HSB).
Study Publicly Available
The English-language study entitled “Enhancing Index-Tracking Performance: Leveraging Characteristic-Based Factor Models for Reduced Estimation Errors” is freely accessible as an open-access publication and can be downloaded via the following link: https://www.sciencedirect.com/science/article/pii/S0377221725006800
“Our work shows that research can also contribute directly to better practice in the financial world,” emphasize the two scientists from the “Dynamics, Tension and Xtreme Events” research and transfer cluster at HSB. “When an ETF truly tracks the index, everyone benefits – investors, fund managers, and the entire financial world.”
Further Information:
https://www.sciencedirect.com/science/article/pii/S0377221725006800
Contact:
Thorsten Poddig
Professor of Business Studies, specializing in Finance
University of Bremen
Phone: +49 (0)421 218-66720
Email: poddigprotect me ?!uni-bremenprotect me ?!.de
