Index Construction for Mid-Cap Equity Index Fund

Imagine you are a portfolio manager at a large asset management firm specializing in passive equity investing. Your firm is considering launching a new index fund that aims to track the performance of the mid-cap segment of the U.S. equity market. As part of the index construction process, you are tasked with evaluating the criteria for selecting constituent stocks that will be included in the index.

Specifically, discuss the key principles of index construction that should be applied in this scenario. Elaborate on factors such as market capitalization, liquidity, sector representation, and any other relevant criteria that would contribute to the index's ability to effectively track the mid-cap market segment. Additionally, provide insights into potential pitfalls or biases that could arise during the index construction process and how to mitigate them.