A Proposal For An Euro Index

Published by Filipe R. Costa on Fri, 13/01/2012 - 12:43
cts euro index

Last year we have proposed a rebalanced USD index to better reflect reality than the originally FED index does. Using six USD pairs as in the original case but rebalancing them to reflect current trades was our goal.

In our article Does The US Dollar Index Reflect Current Reality? we studied how the USD Index would be affected if its components were rebalanced to reflect trading volumes. Our research showed that the final value for the USD would be much different. With this deviation in mind, we decided to apply the methodology used in the referred article to recreate a USD Index.

Using the same methodology used for our CTS US Dollar Index, we decided to create a new index – the CTS Euro Index. The methodology used will be exactly the same as for the USD case. The following rules apply for.

The Creation of the CTS Euro Index and Its Governing Rules

Cut The Spread will start coverage of its own Euro index that will be named CTS Euro index. The index will be based on the following governing rules:

1.    CTS Euro Index, the Index, is a fictional index built by Cut The Spread with the objective of tracking the Euro value in a way that better reflects the current trading turnover reality than other indices.

2.    The Index is not traded in any financial market or over-the-counter, and it should not be used as a proxy for the US Dollar value for investment purposes. The objective behind the creation of the Index is for it to serve as a means of information and for theoretical discussion.

3.    Cut The Spread cannot be liable for any error or omission regarding the construction and updates of the Index and/or any trading losses deriving from it, since its existence is for informational purposes only.

4.    Coverage of the Index will start at the end of 2010, at the last trading day, at the close of markets such that the Index starts being theoretically traded at the beginning of 2011.

5.    The Index will be valued at 100 points at the end of 2010.

6.    The Index will be composed of six currency pairs against the Euro, known as its Constituents.

7.    Initial prices for Constituents will be the closing prices observed in the last trading day of 2010.

8.    Constituents will be derived from the Bank of International Settlements  (BIS) triennial surveys about foreign exchange markets. BIS survey is published every three years at the end of the year and reflects daily turnover data for the month of April regarding currency exchange. Constituents will be the most traded pairs against the Euro, as reported in the survey.

9.    The last published BIS survey was officially published at 1 December 2010. Data derived from this report will be used to start coverage for the Index. The report can be consulted at BIS website.

10. The Index will be rebalanced every three years in accordance with data published in BIS surveys.

11.  The next BIS report will be published at the end of 2013 in which there will be updated data regarding Euro foreign exchange turnover. The Index will be adjusted and rebalanced at the last trading day of 2013 to reflect that data. Constituents will change accordingly, in terms of their weights and their presence in the Index. The procedure will be adopted indefinitely for future surveys.

12. IF BIS report is made available only after the end of the year, the index will be kept unadjusted and unbalanced until the report is available. Upon its availability the index will be changed accordingly seven calendar days after the official release.

13. In case there is a change in BIS triennial survey procedure, regarding dates used to report, time interval between surveys, methodology used to collect data, extinction of the survey, or any other event that can affect the adjustment and rebalancing of the Index, the procedures used to recalculate the Index will be reviewed to reflect the trading turnover reality in the best possible way and respecting the line of reasoning described above.

14. The methodology used to calculate the index is as follows:

CTS Euro Index = K x A^a x B^b X C^c x D^d x E^e x F^f,

such that K is a constant used to standardise the Index to be valued at 100 at the beginning; A,B,C,D,E, and F are the USD pairs with the highest turnovers; a,b,c,d,e, and f are weights for each currency pair. The sum of the exponents must be equal to 100%. Since the sum of the six most traded Euro pairs is not 100% in reality, the data collected from BIS should be rebalanced to 100%. Every time the exchange rate is presented in the form XXX/EUR instead of EUR/XXX the weight should be multiplied by (-1).

15. Based on BIS data collected from the 2010 survey, the starting formula to calculate the Index will be:

CTS Euro Index = 52.83624155 x EUR/USD^0.7635 x EUR/JPY^0.0770 x EUR/GBP^-0.0756 x EUR/CHF^0.0499 x EUR/SEK^0.0243 x EUR/CAD^0.0097.

16. The Index value will be updated once a day and its value published at www.cutthespread.com.

17. Foreign exchange prices will be taken from Sharescope software. Any change to this procedure should be communicated at least three calendar days before, unless, for some external reason, it is impossible to proceed in that way.

18. A record of the Index and Constituents quotes will be kept and can be consulted upon request.

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Research & Opinion