An Active Index for the Sri Lankan Stock Market: a better reflective alternative index

Insights provided from stock indices and their movements play an important role in making investment decisions. This paper aims at building an active index for the Sri Lankan stock market that better reflects the market changes while overcoming the issues in the existing indices such as not capturing the contribution of small-cap companies to the market and adding overvalued stock to the index through market manipulations. Further, the study focused on checking which of the two steps between stock selection and rebalancing has a greater impact on the overall movement of the index. The two models discussed in the paper focus on alternative approaches to weight allocation when rebalancing the indices. However, the paper introduces a single activeness-based stock selection criteria for both models. The models were able to generate indices that performed similarly to the existing indices in the market with an equal or less number of components. All of this was achieved while minimising the drawbacks of existing indices.