Background: Index tracking is a portfolio management which aims to construct anoptimal portfolio to generate similar return with the market index return with onlyselecting few numbers of stocks from the market index. In index tracking, the investorsdo not have to purchase all the stocks exactly in the market index because thetransaction cost incurred is very high. Therefore, index tracking has been introduced toachieve similar return with the market index return without purchasing all the stocksthat make up the index using mathematical model. Objective: The objective of thispaper is to determine the performance of the optimal portfolio constructed withdifferent number of stocks selected from the benchmark market index using mixedinteger linear programming model in index tracking. The portfolio performance isdetermined in terms of tracking error. In this study, the data consists of 24 componentstocks in Malaysia market index which is FTSE Bursa Malaysia Kuala LumpurComposite Index from January 2010 until December 2012. Results: The result showsthat the tracking error for the optimal portfolios constructed with different percentage ofstocks selected from the index are closer to zero. This implies that the optimal portfolioconstructed using mixed integer linear programming model is able to track the marketindex effectively in Malaysia. Conclusion: The optimal portfolio constructed usingmixed integer linear programming model is able to generate similar return with themarket index return effectively without purchasing all the stocks that make up theindex. Therefore, the mixed integer linear programming model is suitable for theinvestors in Malaysia.
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