Summary

The standard indices available for the bond investment markets, are composed of securities that are weighed by the size of the outstanding debt, and are for that reason weighing heavy on the ones most indebted. Those market indices are risky by construction and indeed appear to be. They are shown to be mean-variance inefficient in recent studies, which is disconcerting since that is in contradiction with the principle underlying the Capital Asset Pricing theory that the market as a whole is in price equilibrium. If market-weighted indices are inefficient, market weighting is inefficient!We contribute to a growing literature on this question, which mostly focuses on equities, by testing on bonds. In the construction of market indices we weigh by the fundamental value of the debt issuers rather than their debt size. We do this for sovereigns using Gross Domestic Product figures, and for corporates taking sales revenues. The tests, which we run in the Eurozone over the sovereign debt crisis, add to the evidence that market weighting may indeed be inefficient.

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Authors

Marielle DE JONG
PhD, Head of Fixed-Income Quantitative Research
Hongwen WU
Quantitative Research at Amundi