Question

and compare different weighting methods used in index construction (price weighted, market value weighted, equally weighted)

why equally weighted index require frequent rebalancing?

Answer 1

In the price weighted method the index trading price is based on the trading prices of the individual stocks that are a part of the index. Stocks with a higher price will have more impact on the movement of the index than stocks with lower prices. Thus in a price weighted index the companies that are a part of the index are weighted in proportion to their price per share.

Market value weighted index is based on the total market capitalization of a stock in the index. Market capitalization = no. of shares outstanding*trading price of the share. This is similar to the price weighted index, the only difference being that the amount of outstanding shares comes into play here.

Equally weighted indexes are those indexes in which all stocks have an equal impact on the index price. The weights are not affected by price of the shares or the volume of the shares. Price change of the index is influenced by the return percentage of each stock which is a part of the index.

Equally weighted index requires frequent rebalancing as the returns on the constituent securities keeps on changing on a daily basis and this has to be adjusted in the index.