A systematic literature review on solution approaches for the index tracking problem

Abstract

The passive management approach offers conservative investors a way to reduce risk concerning the market. This investment strategy aims at replicating a specific index, such as the NASDAQ Composite or the FTSE100 index. The problem is that buying all the index's assets incurs high rebalancing costs, and this harms future returns. The index tracking problem concerns building a portfolio that follows a specific benchmark with fewer transaction costs. Since a subset of assets is required to solve the index problem this class of problems is NP-hard, and in the past years, researchers have been studying solution approaches to obtain more practical tracking portfolios. This work brings an analysis, spanning the last three decades, of the advances in mathematical approaches for index tracking. The systematic literature review covered important issues, such as the most relevant research areas, solution methods and model structures. Special attention was given to the exploration and analysis of metaheuristics applied to the index tracking problem.