Three long standing stock indices are examined in this thesis to enable a detailed examination of the behaviour of these indices over time. The DJIA is one of the longest standing market in the US, as is the FT30 in the UK. These two markets are both made up of 30 companies; however their composition makeup’s are quite different. The TOPIX is the longest stock market index in Japan and will enable a comparison between two well developed economies and one developing economy over long sample periods.
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2.10.1. Dow Jones Industrial Average
The DJIA Industrial Average (DJIA hereafter) was created by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow and one of his business associates, Edward Jones. It was first calculated on May 26th 1896 and is the second oldest U.S. index after the Dow Jones Transportation Average. The DJIA is made up 30 large, publically owned companies based in the U.S. The average is price-weighted, and to compensate for the effects of stock splits and other adjustments, it is currently a scaled average. The value of the DJIA is not the actual average of the prices, but rather the sum of the component prices divided by a divisor, which changes whenever one of the stocks has a stock split or stock dividend, so as to generate a consistent value for the index. The current divisor, after many adjustments, is less than one indicating that the index is larger than the sum of the prices of the components. Thus;
∑ (2.7)
Where p are the prices of the component stocks and d it the Dow Divisor. When the DJIA was first calculated in 1896, it represented the average of 12 stocks from leading American industries; with only General Electric currently still part of the index. However, the DJIA has been subject to criticism. Some critics argue that is not representation of the overall market performance of the U.S. due to the small number of stocks it includes and the way it is calculated. They prefer to cite float-adjusted market-value weights indices such as the S&P 500 or the Wilshire 5000 as better indicators of the U.S. stock market. Although the DJIA has received criticism, it is still the most cited and most widely recognized of the stock indices.10
2.10.2. Financial Times 30
The Financial Times 30 (FT30 hereafter) was devised by Maurice Green and Otto Clarke from the Financial News in 1935 and was called the Financial News 30 until the paper merged with the Financial Times in 1945. The index was first calculated on the 1st June 1935 and is the oldest index in the UK.
10 http://www.djaverages.com/
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The FT30 is based on the share prices of 30 British companies from a wide range of industries. It’s method of calculation has been essentially unchanged since its inception and is quite different to most other indices in the UK. The companies listed in the index are made up of those in the Industrial and Commercial sectors and exclude financial sector and government stocks. The price is the equal weighting of the 30 constituents, and the constituents only change when a company needs to be removed for some reason, such as a merger or failure. Thus the FT30 is more stable than all FTSE indices, which decide their constituents based on market capitalisation and change quarterly. The index is calculated by;
∑ ( )
(2.8)
Where FT30today is the price of the FT30 today, FT30yesterday is the price of the FT30
yesterday, Pricei, today is the price of security i today, and Pricei, yesterday is the price of security
i yesterday.
When a company is removed from the index, a new company is selected based on a number of considerations. Firstly, the constituent reflects the breadth of the UK economy. Secondly, that the shares are actively traded and are not in the hands of a small number a holders. Thirdly, that the company is a leader in its field and are UK-based or have UK origins. Finally, the shares trade without any undue influence on the price from overseas, although this consideration is less relevant today. Company size is not of paramount, although all recent additions have been in the FTSE 100 at time of entering the index. Only two original constituents remain in the index from 1935, namely GKN (Guest Keen & Nettlefolds) and Tate & Lyle.11
2.10.3. Tokyo Stock Price Index
The Tokyo Stock Price Index (TOPIX hereafter) is a composite index of all common stocks listed on the First Section of the Tokyo Stock Exchange (TSE) which was established after World War II in 1949. The TOPIX is a measure of the changes in aggregate market value of
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the TSE common stocks and was first measured on 4th January 1951. The base for the index (100 points) is the aggregate market value of its component stocks as of the close on 4th January 1968. The aggregate market value is calculated by multiplying the number of listed shares of each component stock by its price and totalling the products derived there from. In computing the index, the base market value is used as the denominator of a fraction whose numerator represents the current aggregate market value. The fraction is multiplied by 100 (the index value on the base date) and is reduced to a decimal figure to the nearest one- hundredth12. Thus;
(2.9)
The TOPIX is the longest-standing stock market in Japan and although calculated quite differently to the DJIA and FT30, its availability of long-standing data makes it an obvious choice.