Index revision

		Why does the index keep changing from time to time?
		When a stock goes out and a new stock comes in, doesn't that make index levels non-comparable?
		Index revision sounds dangerous in terms of political pressures. Won't speculators try to push a stock they have purchased into the index? Or remove a stock from the index when they are shorting it?

Why does the index keep changing from time to time?
Think of a liquid stock as a good thermometer, one which gives accurate data about the true price of the stock, because it trades actively with a tight spread. The prices observed for an illiquid stock are like readings from a low quality thermometer, which reports noisy data about the phenomenon of interest (the true price of the security). We try to find the fifty best thermometers in the country and average their values to make the S&P CNX Nifty. As time passes, better thermometers become available (in the form of large, liquid stocks that are not in the S&P CNX Nifty). We would like that S&P CNX Nifty always uses the best thermometers possible. So we remove the weakest thermometer from inside the S&P CNX Nifty and accept the new stock into it. The world changes, so the index should change. Yet, the change should not be sudden - for that would disrupt the character of the index. S&P CNX Nifty uses clear, researched and publicly documented rules for index revision. These rules are applied regularly, to obtain changes to the index set. Index reviews are carried out every six months to ensure that each security in the index fulfills all the laid down criteria. IDBI was once not listed; SBI was once illiquid; Infosys was once an obscure software startup. The world changes, and one by one, these stocks have come into the S&P CNX Nifty. Each change in the S&P CNX Nifty is small, so the continuity of the index is maintained. Yet, at all times, S&P CNX Nifty represents the 50 most important liquid stocks in the country, the best thermometers to build an index out of.

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When a stock goes out and a new stock comes in, doesn't that make index levels non-comparable?
No. There are mathematical formulas, which ensure that yesterday's value and today's are comparable, even if a change in composition takes place in-between. Think of an index as a portfolio. The composition of the portfolio changes, but it is still meaningful to keep measuring the overnight returns on the portfolio from day to day. These returns, cumulated up, are the index level.

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Index revision sounds dangerous in terms of political pressures. Won't speculators try to push a stock they have purchased into S&P CNX Nifty? Or remove a stock from the index when they are shorting it?
Of course they will. Hence there are no speculators on the internal committee of IISL, which manages the index revisions. Further, there are objective, publicly defined rules which determine when stocks come in and go out of the index. There isn't much room for personal judgement here.

Last updated on March 10, 2008.