An Empirical Study On Performance And Risk Of Index Funds In China

Since nineties of 20th century, investment funds emerged in China. With continuous growth of Chinese security market, investment funds became stronger as well as more diversified. By the end of 2007, there were twenty one index funds in China whose gross asset value was about twenty two billion and six hundred million RMB. So index funds had became important role in funds industry of China.As an important role in funds industry, index fund is a type of passive managed fund. Aimed to security index, index fund replicates and follows an index or a benchmark. An index fund tries to keep its return aligned with return of its benchmark. So return of index fund correlates with its benchmark's return closely. And return of index fund changes with fluctuation of return of its benchmark. The return difference between index fund and its benchmark is called tracking error, which is an important variable to measure index fund's yield and risk.The paper follows the logic as followed: Issue—Analysis—Solution. Aimed to tracking error, the paper proposes a basic question. That is how to determine tracking error of index fund. Then two questions are proposed. One, how many parts can be decomposed for an index fund? Two, based on decomposition of tracking error variance, how to find risk source of index fund and to predict future risk of index fund.Concisely the paper's logic is as followed. In first part the paper introduces the development of index funds worldwide. It also focuses on history of index funds and its future in China. In second part the paper introduces many important literatures on indexing. And it also relates both theory of stress test and its methods for financial risk management. In part three the paper deduces a general framework of tracking error. Tracking error variance is decomposed in different ways for risk feature analysis. In part four based on models above, the paper analyzes both return and risk empirically. Finally the paper reaches its conclusions.There are seven chapters in the paper. The basic structure is followed.Chapter one is an introduction. It shows the background and the importance of the paper at first. Then it introduces foundations of theory and methods used in the paper. Finally it shows the basic ideas and structure of the paper.Chapter two is a brief discussion on index funds development. Firstly it introduces the basic idea about index funds including its definition, types and features. Then it introduces both replication methods and investment procedures of indexing. After that it relates the development of index funds domestically as well as internationally. Finally it also introduces some important evaluation systems for index funds performance.Chapter three is a literature review. In this chapter the paper shows different literatures related. And it focuses on the important ones at first. Then it relates theories and approaches about stress test for financial risk management.In chapter four the paper analyzes tracking error of index funds theoretically. At first the paper deduces a general framework in tracing error expression. Then it imposes different variable constraints on the expression to reach different tracking errors. Finally it focuses on the important measure of tracking error that is tracking error variance. And tracking error variance is decomposed in different ways.In chapter five the paper analyzes historical performance of China's index funds empirically. At first it puts forward an evaluation model for tracking error. Then based on the model above, it selects sample index funds to analyze their tracking error as well as other variables to evaluate their historical performance.In chapter six the paper decomposes tracking error variance empirically at first. Then by means of empirical models, it analyzes tracing error variance and their determinants. After that it introduces stress model to forecast the risk of sample index funds.Chapter seven is the last one in the paper. In this chapter, the paper summarizes the conclusions and the shortcomings in the paper. Then it proposes some countermeasures for index funds management in China.The conclusions in the paper are followed.Firstly the paper introduces the basic ideas about index funds including its definition, types and features. Both replication methods and investment procedures of indexing are discussed. It also relates theories and approaches about stress test for financial risk management. Some important evaluation systems are proposed for index funds performance.Secondly a general framework is deducted in tracing error expression. Then tracking error variance can be decomposed into expected tracking error variance and random tracking error variance. Moreover random tracking error variance can also be decomposed into benchmark exposure and residual tracking error variance. At the same time the paper decomposes tracking error variance into systematic risk and unsystematic risk. It also divides tracking error variance into timing and selection. Then the paper also analyzes positive investment style and its risk. Based on comparative static analysis, the paper analyzes relation between tracking error variance and its determinants. It also studies correlation coefficient between an index fund and its benchmark.Thirdly the empirical analysis on historical performance is finished. The results show that in general China's index funds fulfill their indexing target. And their returns replicate benchmark returns in a good way.At last, the paper finds the main factors to determine the risk of China's index funds by means of decomposition of tracking error variance. Based on stress testing, the paper forecast future risk of sample index fund.The innovations in this paper are followed.Firstly the paper deduces a general framework in tracing error expression. Based on the framework, the paper decomposes tracking error variance. Combined with asset pricing theory, it proposes empirical models for future research.Secondly compared with other empirical studies related in China, the paper analyzes much more index funds that mean much more data available in the paper. At the same time the data has longer time span.Thirdly in empirical part, the paper uses many methods to analyze sample index. The methods available are comparison analysis, comprehensive ordering analysis and group analysis etc.Finally the paper introduces stress test to evaluate future risk of index funds in China. It's a helpful approach for risk management of index funds in China.