rket owing to (a) low market impact cost and (b) high hedging effectiveness. The good diversification of NIFTY 50 will generate low initial margin requirements. Finally, NIFTY 50 is calculated using NSE prices, and NSE is the most liquid exchange in India, thus making it easier to do arbitrage for NIFTY 50 index futures.
This can, indeed, be done. Is it worth doing? That depends upon the cost and benefit. Calculating the weights, in the ten stocks with the lowest market impact cost, so that the correlation with NIFTY 50 is maximised, is not easy to do. (See Risk structure of Indian stocks by Dr. John Blin of Advance Portfolio Technologies APT - http://www.aptltd.com for a calculation of a 10-stock portfolio which is maximally correlated with NIFTY 50. This is found in the book "The future of fund management in India" edited by Dr. Tushar Waghmare, "Invest India" - Tata McGraw Hill Series, 1997 - http://www.iief.com)
The gains from such an activity are not large. NIFTY 50 is explicitly designed to make it convenient to trade complete index portfolios. This is in contrast with other markets, where indices have arisen before index futures came about, and ways had to be found to trade them. For example, the 500 index was there before index futures came about. When index futures started trading, arbitrageurs had to find ways to trade the index - trading 500 stocks on the floor-based New York Stock Exchange was highly cumbersome. This led to great creativity in finding 250-stock portfolios which correlate well with the 500. In India, there is no need to undergo these kinds of problems. NIFTY 50 is the base of the index futures, and NIFTY 50 is designed to be convenient to trade directly.
Alternatives to the NIFTY 50
Every technical reason favours the NIFTY 50.
DiversificationNIFTY 50 is a more diversified index, accurately reflecting overall market conditions. The reward-to-risk ratio of NIFTY 50 is higher than other leading indices, making it a more attractive portfolio hence offering similar returns, but at lesser risk.
Liquidity. Over one year (October 1998 to October 1999), the trading volume on NSE for NIFTY stocks was ₹ 3.5 trillion, giving a liquidity ratio of 105%. The 'liquidity ratio' is defined as trading volume over one year divided by market capitalisation today.
Hedging effectiveness. The basic risk of NIFTY futures will be lower owing to the superior liquidity of NIFTY stocks and of NSE. NIFTY has higher correlations with typical portfolios in India as compared to any other index. These two factors imply that hedging using NIFTY futures will be superior.
Governance. NIFTY is managed by a professional team at NSE Indices. There is a three-tier governance structure comprising the board of directors of NSE Indices, the Index Policy Committee, and the Index Maintenance Subcommittee. NIFTY 50 has fully articulated and professionally implemented rules governing index revision, corporate actions, etc. These rules are carefully thought out, under Indian conditions, to dovetail with operational problems of index funds and index arbitrageurs. NIFTY 50 is relatively free of manipulation, for three reasons: (a) the index levels are calculated from a highly liquid exchange with superior surveillance procedures (b)NIFTY 50 has a large market capitalisation so the consequence (upon the index) of a given move in an individual stock price is smaller and (c)NIFTY 50 calculation intrinsically requires liquidity in proportion to market capitalisation, thus avoiding weak links which a manipulator can attack. Users of the NIFTY 50 benefit from the research that is possible owing to the long time-series available: both NIFTY 50 and NIFTY 50 Total Returns Index series are observed from July 1990 onwards.NIFTY 50 is backed by solid economic research.
Equities trading at NSE began in November 1994. By late 1995, NSE became India's largest equity market and was looking for a market index to utilise this unique information source. NSE also wanted to have a vehicle for the futures and options market. NSE approached the economists Dr. Ajay S