Some ideas for improving quality of the index tracking based on cointegration

Abstract

Cointegration approach to the passive portfolio management enables to replicate the selected stock index and to construct a portfolio with profitability and risk similar to market. This paper analyzes several options for improving this method. It focuses on one of the key tasks, which is an estimate of long-run equilibrium relationship. Five different methods were proposed and compared. The results confirmed the relevance of using the Engle-Granger methodology in all previous surveys, but it also suggested some interesting properties related to the estimate of regression coefficients based on different variants of the Minkowski metric or to estimate regression equation without intercept. KeywordsCointegration cointegrating vector long-run equilibrium relationship Minkowski metric Engle-Granger methodology Johansen's cointegration method JEL Classification G11