The rationale of continuing DGEN

Author Topic: The rationale of continuing DGEN  (Read 1688 times)

Offline Rozina Akter

  • Hero Member
  • *****
  • Posts: 887
  • Test
    • View Profile
The rationale of continuing DGEN
« on: August 05, 2013, 12:30:04 PM »
In its 749th board meeting, the Dhaka Stock Exchange (DSE) decided to discontinue the DSE General Index (DGEN) from August 01, 2013. Accordingly, the DSE removed the index from the trading board on the first day of next month. The DSE now promotes two indices: DSEX and DSE30 that follow the free float S&P (Standard & Poor's) methodology. Instead of using all the shares outstanding as in the full-market capitalisation, which the DGEN followed, the free-float method excludes locked-in shares held by promoters and governments. The DSE30 covers top 30 companies from different sectors and is considered as a narrow index and the DSEX is considered a broad index. Both contain the historical data and use the base value of 2008. However, today we would like to urge the concerned authority to continue the DGEN at least for five more years. Why?

Before we delve deep into it, we would like to say a few words on 'market portfolio'. The idea of market portfolio plays a key role in financial research. In theory, a market portfolio consists of all types of assets in a given market where each asset is weighted to the percentage of the total value of assets in the market. Here 'asset' means every single thing, e.g., real estate, gold, derivative, stock, etc. It is virtually impossible to have a market portfolio in reality. This is where 'market index' plays its role. A market index is used as the proxy for the market portfolio. In Bangladesh, the DSE All Share Price Index (DSI) and the DGEN have been used as a proxy for the market portfolio. However, the DSI was eliminated from the DSE trading board on January 24 last and the DGEN was discontinued on Aug 01, 2013. Now remain the DSEX and DS30 indexes.

Discontinuing the DGEN will discourage any fundamental analysis in the DSE. In the fundamental analysis, an investor needs to know beta, i.e., systematic risk involved in a stock. To calculate beta, one should take about 10 years of return on the market portfolio, i.e., market index. If you take too less data, for instance, of 5 years, there is every possibility that you could overestimate the market risks and thus the expected return. Since Bangladesh faced a severe market crash in 2010-11, it is certain that an investor will overestimate the market risk by using 5 years' (2008-2013) data on the DSEX. It could lead to faulty valuation of a stock and put one at risk of losing his life-time savings in the market. The lack of a reasonable amount of data on the market index will effectively discourage any fundamental analysis in the DSE.

Both the DSEX and the DS30 indices consider 2008 as the base year and thereby have hardly 5 years' historical data. For accurate calculation of return on market portfolio, five years' data may not be acceptable. For the DSE General Index (DGEN), 2001 was the base year and therefore it has the historical data for around 12 years which can give a more accurate figure as a proxy for the market portfolio. Also the market crash of 2010 could have severely influenced all the indexes including the DSEX and the DSE30. Taking a longer period will smoothen out the impact of the market crash in 2010.

Moreover, if you want to carry out a research on any topic in finance where you need to use long-time data including market index as a proxy for the market portfolio, for bias-free results you need to use at least 10-15 years' data. However, discontinuing the DGEN will virtually discourage researchers because of the lack of data on market portfolio, i.e., market index. Also using the DSEX, which has only about 5 years' data right now, could lead to biased results.

For example, if you want to see whether the budget deficit has any impact on the stock prices, you need to use 10-15 years' data. If the DGEN discontinued, you have two options left to conduct the research on this topic. Either you have to take sample data before June 2013 or you need to use the recent data starting from 2008. However, in any financial research, because of market efficiency, no one really is interested in a result that is based on an old set of data. And if you use data from 2008 to perform the above mentioned research, your result will be biased because of the small sample size.

If you follow the research trend in Bangladesh for the last 4 or 5 years, you will notice that Bangladeshi young researchers are also doing an excellent job in different financial researches. Terminating the DGEN will discourage the researchers in the financial sector, which will lead to the DSE's severe inefficiency.

You might say the DGEN contains inflated points due to faulty calculations. Statistically it has been found that the DGEN return data is not that different from the DSEX return data. Thus, even with faulty calculation, one can use the DGEN instead of the DSEX as a proxy for market portfolio in Bangladesh.

Since the DSE already has the mathematical expression and software for the DGEN, it wouldn't cost a dime extra to continue this dying index for at least next five years until we have data on the DSEX at least for a total of ten years.

Therefore, closing down the DGEN will not be a wise decision by the regulator. Moreover, a glimpse of other developed markets will tell us there are many indices existing together in a stock market and with the advancement of technologies, maintaining such indices are rather easy and cost effective. Hence the authority should reconsider the decision on the DGEN. The authority should continue the DGEN unless we have the DSEX data for at least ten years.
Rozina Akter
Assistant Professor
Department Of Business Administration