Empirical analysis of index tracking with efficient portfolio dimension reduction and smart beta score

Using the efficient portfolio dimension reduction method proposed by Liu, Wang, and Tan[1],this paper combines the efficient portfolio dimension reduction with stock selection criterions of six smart-beta factors (profit, growth, safe, dividend, quality and momentum) to track the top 50 big cap equally-weighted stock index of Taiwan stock market. We adopt the rolling window method with month basis during the period from Jan, 2010 to Apr, 2017. The tracking stock index is composed of the top 50 big cap stocks and is renewed at first trade day at each month. Given appropriate in-sample periods and parameter, the empirical results show that the tracking EPDR portfolio rule outperforms the equally weighted stock index. Compared to the equally-weighted portfolio of top 50 big cap stocks, the EPDR portfolio rules only hold 10 to 20 assets on averages. In addition, the monthly returns of the EPDR portfolio rules are highly correlated with those of equally-weighted stock index of top 50 big cap stocks, which implies that the EPDR method may have good performance in index tracking.