Is Index Concentration an Inevitable Consequence of Market-Capitalization Weighting?
Vol. 21, No 2, 2023
by Lisa R. Goldberg, Ananth Madhavan, Harrison Selwitz and Alexander Shkolnik
Market-cap-weighted equity indexes are ubiquitous. However, there are growing concerns that such indexes are increasingly concentrated in a few stocks. We ask: Does market-cap weighting inevitably lead to increased concentration overtime? The question of inevitability arises from research that develops probabilistic causal mechanisms for the dominance by a few firms over time. We show that while the concentration currently observed in major equity market indexes is substantial, it is not at an all-time high. Monte Carlo simulations calibrated to market data provide insight into various approaches to mitigate concentration, albeit at the expense of higher turnover.