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MBA students analyze new stock index

Thursday, January 3, 2013

 

LAWRENCE — Ask any business student if they've heard of the S&P 500, the Nasdaq-100 or the Dow Jones Industrial Average, and the answer will be, "absolutely." Of course, those aren't the only stock market indices. According to Yahoo Finance, there are nearly 50 in the United States alone, including one in our own backyard.

BATS Global Markets Inc. (BATS) is a company headquartered in Lenexa, Kan., that operates stock and options markets in the U.S. and Europe. BATS is the third-largest stock exchange operator in the world, behind the NYSE Euronext Group and NASDAQ OMX. Three years ago, BATS created the BATS 1000 Index, a U.S. equities market benchmark designed to help investors gauge current market conditions.

"There's no doubt that the BATS methodology is unique from the other indices," said Boone Bradley, a Master of Business Administration student at the University of Kansas School of Business.

In November, Bradley and fellow MBA student Benjamin Gaydess-Hodgins finished a study of the BATS 1000 Index. Their goal, while providing an outside and unbiased view on the index, was to discover if it produced a unique performance because of its distinctive methodology. The conclusion the graduate students came to is that the index hasn't been around long enough to make a definitive decision about its performance.

"The problem is that there is only two or three year's worth of data," Bradley said. "There are these big economic cycles that can take decades to play out, and it's those long-term cycles the BATS methodology is designed to address."

The factors that make the BATS methodology different from other indices come out of the recent financial crisis. The goal was to come up with something different from the other indices but still representative of the economy and the trading activity within it, Gaydess-Hodgins said. The BATS 1000 weights sectors equally so the index does not just reflect the performance of an abnormally good or bad sector.

"In the big market indices, like the S&P 500, before and during the crisis, financials made up more of the index than anything else. That's why the S&P 500 crashed as significantly as it did during the financial crisis," Gaydess-Hodgins said. "BATS idea was to limit each sector of the economy to ten percent of the index so a financial crash would have a smaller impact."

Reports like this one tell investors about the performance characteristics of the index, Bradley said. In times like this, investors want something a little more stable.

"You do something new and what is it really doing? What did it do day-to-day and what's going to happen if the market goes way up or way down?" Gaydess-Hodgins asked. "Understanding that behavior is important because people are always looking for an edge, more return for less risk."

In addition to providing investors with useful data, Bradley said, these reports also help validate a company's index because a prestigious institute, like KU, can say it's a legitimate index.

"We were excited to partner with KU on this research project about the BATS 1000 Index," said Ken Conklin, senior vice president of business development at BATS. "Three years ago we set out to create a new U.S. equities benchmark that would capture the overall mood and market disposition more effectively, and we're excited about the track record of the BATS 1000 Index."

Altogether, it took the two MBA students about six months to complete the report.

"We weren't really sure what to expect going into the project," Gaydess-Hodgins said, "but it was worth doing. We learned there is a lot more going on behind the scenes with the people that operate these indices than most people think."

"It's been a really good experience and a pleasure for us, as MBA students, to work with an established, growing company like BATS," Bradley said. "Although we have some faculty on staff who have worked in the field, there's not a class for making a stock market index, so this has been a really good research opportunity. It's been a fascinating look inside the industry."

Boone Bradley is originally from Wichita, Kan., and earned a bachelor's degree in philosophy from KU in 2002. Ben Gaydess-Hodgins is originally from Anchorage, Alaska, and earned a bachelor's degree in math and economics from Williams College. Bradley earned his MBA degree in December and Gaydess-Hodgins will earn his MBA and become a KU School of Business alumnus in May.