Abstract

An Index Is an Index Is an Index?

Thorsten Freihube and Erik Theissen

University of Frankfurt

Stock trading in Germany is characterized by the co-existence of floor and screen trading. The market share of the electronic trading system (until November 1997 IBIS, thereafter XETRA) has risen steadily in recent years. This increase is largely due to high market shares for the most liquid stocks. XETRA proved to be rather illiquid for small caps. Despite these concerns Deutsche Börse AG decided in January 1999 that, from June 1999 onwards, the indices DAX and MDAX would only be calculated from XETRA prices. Prior to June 1999, two parallel index values were published, one calculated from floor prices and the other from XETRA prices. According to Deutsche Börse AG, the reason for the policy change was the increased importance of electronic trading.

A more differentiated view might be appropriate. The DAX index comprises the 30 most liquid German stocks. For these stocks the market share of XETRA is larger than the market share of the floor. However, the reverse is true for the 70 mid-cap stocks which form the MDAX index. If trading volume were the only criterion, it might thus be appropriate to calculate the DAX from screen trading prices and the MDAX from floor trading prices. However, there might be criteria beyond trading volume. For example, price discovery might be better in one of the trading systems. In this case, an index calculated from the prices of this trading system might be more informative even if the trading volume was lower.

The objective of our paper is to analyze the quality of the two indices empirically. We obtained intradaily data for the DAX and the MDAX index for both the floor and XETRA. As criteria for the quality of an index we use the volatility of the returns, the autocorrelation patterns, the predicitve power of the index returns, and the results of a VECM. The importance of our results extends beyond the actual decision taken by Deutsche Börse because they provide insight into the relative merits of floor and screen trading systems.