The S&P CNX Nifty

		How does the S & P CNX Nifty work?
		What is `impact cost'?
		What do you mean by `an S&P CNX Nifty trade'?
		What's the impact cost on Rs.5 million of the full S&P CNX Nifty?

How does the S&P CNX Nifty work?
S&P CNX Nifty is based upon solid economic research. A trillion calculations were expended to evolve the rules inside the S&P CNX Nifty index. The results of this work are remarkably simple: (a) the correct size to use is 50, (b) stocks considered for the S&P CNX Nifty must be liquid by the `impact cost' criterion, (c) the largest 50 stocks that meet the criterion go into the index. S&P CNX Nifty is a contrast to the adhoc methods that have gone into index construction in the preceding years, where indices were made out of intuition and lacked a scientific basis. The research that led up to S&P CNX Nifty is well-respected internationally as a pioneering effort in better understanding how to make a stock market index. See "Market microstructure considerations in index construction" by Ajay Shah and Susan Thomas, CBOT Research Symposium Proceedings, Summer 1998, page 173-193.

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What is `impact cost'?
Suppose a stock trades at bid 99 and ask 101. We say the "ideal" price is Rs. 100. Now, suppose a buy order for 1000 shares goes through at Rs.102. Then we say the market impact cost at 1000 shares is 2%. If a buy order for 2000 shares goes through at Rs.104, we say the market impact cost at 2000 shares is 4%. Market impact cost is the best measure of the liquidity of a stock. It accurately reflects the costs faced when actually trading an index. For a stock to qualify for possible inclusion into the S&P CNX Nifty, it has to reliably have market impact cost of below 0.75 % when doing S&P CNX Nifty trades of half a crore rupees.

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What do you mean by `an S&P CNX Nifty trade'?
Earlier, we said that the index assigns weightages to index components, and the weight of a stock is proportional to its market capitalisation. This idea can be applied to buying the S&P CNX Nifty. If you buy all 50 stocks in the S&P CNX Nifty, in correct proportions, that would be called "an index trade".".

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What's the impact cost on a trade for Rs.5 million of the full S&P CNX Nifty?
It is safe to think that the impact cost is 0.1% or so. This means that if S&P CNX Nifty is at 1000, a buy order goes through at 1001 and a sell order gets 999. NSE's NEAT software has special facilities to enable buying or selling the entire the S&P CNX Nifty at one shot. The impact cost is not something fixed. It changes, depending upon the liquidity of the market. Indeed, the time-series of the S&P CNX Nifty impact cost is one of the best measures of changes in market liquidity over the years.

Last updated on March 10, 2008.