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On Construction of Robust Composite Indices by Linear Aggregation

On Construction of Robust Composite Indices by Linear Aggregation

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Published by Sudhanshu K Mishra
In this paper we construct thirteen different types of composite indices by linear combination of indicator variables (with and without outliers/data corruption). Weights of different indicator variables are obtained by maximization of the sum of squared (and, alternatively, absolute) correlation coefficients of the composite indices with the constituent indicator variables. Seven different types of correlation are used: Karl Pearson, Spearman, Signum, Bradley, Shevlyakov, Campbell and modified Campbell. Composite indices have also been constructed by maximization of the minimal correlation. We find that performance of indices based on robust measures of correlation such as modified Campbell and Spearman, as well as that of the maxi-min based method, is excellent. Using these methods we obtain composite indices that are autochthonously sensitive and allochthonously robust. This paper also justifies simple mean-based composite indices often used in construction of human development index.
In this paper we construct thirteen different types of composite indices by linear combination of indicator variables (with and without outliers/data corruption). Weights of different indicator variables are obtained by maximization of the sum of squared (and, alternatively, absolute) correlation coefficients of the composite indices with the constituent indicator variables. Seven different types of correlation are used: Karl Pearson, Spearman, Signum, Bradley, Shevlyakov, Campbell and modified Campbell. Composite indices have also been constructed by maximization of the minimal correlation. We find that performance of indices based on robust measures of correlation such as modified Campbell and Spearman, as well as that of the maxi-min based method, is excellent. Using these methods we obtain composite indices that are autochthonously sensitive and allochthonously robust. This paper also justifies simple mean-based composite indices often used in construction of human development index.

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Published by: Sudhanshu K Mishra on Jun 20, 2008
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On Construction of Robust Composite Indices by Linear Aggregation
SK MishraDepartment of EconomicsNorth-Eastern Hill University, Shillong (India)mishrasknehu@yahoo.com
Abstract
In this paper we construct thirteen different types of composite indices by linear combination of indicator variables (with and without outliers/data corruption). Weights of different indicatorvariables are obtained by maximization of the sum of squared (and, alternatively, absolute)correlation coefficients of the composite indices with the constituent indicator variables. TheDifferential Evolution method has been used for global optimization. Seven different types of correlation are used: Karl Pearson, Spearman, Signum, Bradley, Shevlyakov, Campbell andmodified Campbell. Composite indices have also been constructed by maximization of theminimal correlation. We find that performance of indices based on robust measures of correlation such as modified Campbell and Spearman, as well as that of the maxi-min basedmethod, is excellent. Using these methods we obtain composite indices that areautochthonously sensitive and allochthonously robust. This paper also justifies simple mean-based composite indices, often used in construction of human development index.
Keywords:
Composite index, Linear aggregation, Principal components, Differential Evolution,Global optimization, Robust correlation, Signum, Bradley, Absolute correlation, Shevlyakov,Campbell, Hampel, Outliers, Mutilation of data
JEL Classifications:
C13, C43, C61, C87, C88
 
2
On Construction of Robust Composite Indices by Linear Aggregation
SK MishraDepartment of EconomicsNorth-Eastern Hill University, Shillong (India)mishrasknehu@yahoo.com
I. Introduction
: A composite index (
n I 
,1:
=
) is often a (weighted) linear aggregation of numerous indices (
nm j x
kj
,1;,1:
==
) such that
kjm jj
xw I 
=
=
1
. As to the assignment of weights to different indices, there are two approaches: the first in which the weights aredetermined on the basis of some information or considerations exogenous to the data on indexvariables (
),
 X  x
kj
and the second in which the weights are endogenously determined suchthat
).(
 X  f w
=
The most robust composite index is the one that uses exogenously determinedweights since in that case
w
is used as a parameter and, therefore,
).|(
w X  I 
ϕ 
=
However,when weights are endogenously determined, we have
)).(,(
 f  X  I 
ϕ 
=
In this latter case, thecomposite index,
,
 I 
depends not only on the index variables,
,
 X 
but also on the specificationof the function,
(.),
 f 
that obtains weights,
,
w
from
.
 X 
 To make this point clearer, let
kj
 x
be perturbed such that
kjkjkj
x x
+
where
.0
kj
If weights are not derived from
,
 X 
then
kj j
w I  I 
+
and
.
i k i
 I
That is, theperturbation affects
 I 
only. However, if weights are derived from
,
 X 
a perturbation of one of the values of 
kj
 x
would in most cases alter the values of 
w
as well as the values of 
.,1
n I 
=
 A perturbation of 
kj
 x
will pervade throughout even though all of 
:
ip
 x i k p j
haveremained unchanged. The extent of pervasiveness, which is not a desirable property of thecomposite index, would depend on the specification of 
).(
 X  f w
=
 There is an additional point to be noted. When
,)|(
Xww X  I 
==
ϕ 
the weight,
 j
w
,which may be viewed as
 j
 x I 
is constant and hence
 I 
is indeed a linear combination of 
.
 X 
 However, when
)),(,(
 f  X  I 
ϕ 
=
the weight,
,
 j
w
in general , is not constant and, therefore,
 I 
 is not a linear combination of 
.
 X 
In that case, these weights, which may also be viewed as therate of substitution among different constituent indices, lose interpretability in any simplemanner and hence go far off the desirable property of easy comprehensibility.
II. Two Desirable Propertied of a Composite Index
: Now we enunciate two desirable propertiesof a composite index: (i) change in
kj
 x
best be reflected into a change in
 I 
, which we callsensitiveness, and (ii) change in
kj
 x
be least reflected into changes in
,:
i I 
i
which we willcall robustness. Sensitiveness implies stronger correlation between the composite index,
,
 I 
andthe constituent index variables,
.
 X  x
 j
On the other hand, robustness implies insensitivenessof 
w
to changes in
.
 X 
 
 
3
III. The Simplest Method of Construction of a Composite Index
: Perhaps the simplest methodof constructing a composite index is to obtain
.,1:) / 1(
1
=
==
m jkj
n xm I 
It implies
.,1: / 1
m jmw
 j
==
Viewed as such, this method yields a robust composite index. It alsofollows the law of insufficient reason; that in absence of any indubitable basis of determiningthe weights assigned to different index variables, they all carry equal weights. In the last fewyears, after it was used for construction of the ‘human development index’, this method haswon many adherents. In applying this method, on many occasions, the index variables,
,
s x
 j
arestandardized or normalized in some manner such that
)),(( / )(
 j j j
xgnorm xg x
where
)(
 j
 xg
is a monotonic function of 
.
 j
 x
The
))((
 j
 xgnorm
may be
),((ˆ)),((max
 jkj
 xg xg
σ 
|,)(|
 jkj
 xmed  xmed 
etc. The choice of a suitable norm is important. Certain types of normmay run against the desirable property of robustness. On the other hand, sensitiveness of thecomposite index constructed by this method is rather suboptimal.
IV. The Method of the Principal Components Analysis
: The well known Principal ComponentsAnalysis (PCA) is another method to obtain the composite index. It attributes two properties to
 Xw I 
=
: first, that it maximizes the sum of squared (Karl Pearson’s or product moment)coefficients of correlation between
 I 
and
,,1;
m j x
 j
=
and the second, that it is orthogonal toany other index,
,:
wv Xv J 
=
that may be derived from
 X 
by maximization of the sum of squared correlation coefficients between
 J 
and
.
 j
 x
Stated differently, the PCA-basedcomposite index satisfies two criteria: i)
),(:
12
 jm j
 x I  Xw I 
=
=
is maximum, and ii) if 
),(max:
12
=
=
m jj
 x I  Xw I 
and
,);,(max:
12
vw x J  Xv J 
 jm j
=
=
then the coefficient of correlation between the two such composite indices,
.0),(
=
 J  I 
Except in an extremelyspecial case when the constituent index variables themselves are pair-wise orthogonal,
 I 
and
 J 
both cannot attain the global maximum. The global maximizer composite index is unique.The technique to obtain such a (unique) global maximizer composite index by PCAconsists of, first, obtaining the matrix,
,
 R
of correlation coefficients,
,
 R
ij
between each pairof index variables,
i
 x
and
,
 j
 x
and, then, obtaining the eigenvalues (
m
λ λ λ 
,...,,
21
) and theeigenvectors (
m
uuu
,...,,
21
) of 
.
 R
The eigenvectors are then normalized to satisfy the condition
 ju
 j
=
1||||
(or, sometimes,
 ju
 j j
=
λ 
||||
), where
|| ||
i
denotes the Euclidean norm. Thesenormalized eigenvectors are used as weights to construct the composite indices. The indexconstructed by using the eigenvector associated with the largest eigenvalue is often used as thefirst best composite index. This index attains the global maximum mentioned earlier.The composite index thus obtained has many optimal properties. However, this PCAbased index is often elitist (Mishra, 2007-b), with a strong tendency to weight highly correlatedsubset of 
 X 
favourably and relegating poorly correlated index variables to the subsequentprincipal components. In practice, when one has to use only one composite index to represent
,
 X 
the poorly correlated index variables remain largely unrepresented. Since correlation is nomeasure of importance, many highly important but poorly correlated index variables may thusbe undermined by the PCA-based composite index.

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