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IJRAR1903713 International Journal of Research and Analytical Reviews (IJRAR) www.ijrar.org 543

EFFECTS OF STOCK INCLUSION TO OR

EXCLUSION FROM THE STOCK MARKET

INDEX: A SURVEY OF LITERATURE FROM 24

COUNTRIES

Dhirendra Nath Mahata

Assistant Professor of Commerce

Syamsundar College

Shyamsundar, Burdwan, West Bengal, India

Abstract: Many empirical studies around the world show the evidence of abnormal change in the price and trading volume,

volatility, bid-ask spread of the stocks included to or excluded from the index when the reorganization of index is occurred. These

changes are observed around the Announcement Date and the Effective Date of the event. Researchers have proposed various

explanations regarding these uncharacteristic changes. There are several explanations but current research in this area suggests six

important hypotheses – Downward Sloping Demand Curve (DSDC), Price Pressure Hypothesis, Liquidity Hypothesis,

Information Content Hypothesis, Investor Awareness Hypothesis and The Selection Criteria Hypothesis. In this article the attempt

has been made to understand the behaviour of stock price, trading volume and volatility of the stocks which are included to or

excluded from stock market index all over the world by reviewing literatures from various countries.

Key words: Index Revision, Index Effect, Price Pressure Hypothesis, Downward Sloping Demand Curve.

Introduction: Stock market is a place of attractive investment destination all over the world. Movement of stock prices depends

upon various factors and events. Investors, traders, speculators, arbitrageurs, fund managers, brokers – all want to know these

factors and events and they try to understand how these affect the price movements of stocks. Index revision is such an event.

Many empirical studies around the world show the evidence of abnormal change in the price and trading volume of the stocks

included to or excluded from the index when the reorganization of index is occurred. In addition to the change in stock price and

trading volume there may be some impact on bid-ask spread or on volatility of the event. The effect of index change is known as

index effect. These changes are observed around the Announcement Date and the Effective Date of the event. But, if the markets

are efficient and the information of index composition change available to public there is no reason of believing such type of

impact. The main assumption of Efficient Market Hypothesis (EMH) is the investors are rational and they value the securities

rationally. This implies that security price always reflects all available information and no one can earn any abnormal return or

excess return by using the information of a security. According to the EMH, the security price is the intrinsic value or the

fundamental value of the security. This fundamental value is the net present value of the future cash flows discounted by

appropriate risk factor. So, the security price will change only when the new information comes and which have an effect on

company fundamentals. But only the information of inclusion or exclusion of stocks does not have any impact of company’s

fundamental and consequently there should be no effect of this event on stock price or trading volume. The arbitrage theory states

that if there is any deviation from the fundamental value the investors will buy the undervalued firm and sell the overvalued firm

because there are some perfect substitutes in the market and hence the demand curve of any security is perfectly elastic. So, this

theory also supports that the stock inclusion to or exclusion from stock market index has no effect on stock price.

In this article the attempt has been made to understand the behaviour of stock price, trading volume and volatility of the

stocks which are included to or excluded from stock market index all over the world by reviewing literatures from various

countries.

Theoretical Foundation of the Study: When the stocks are simply included to or excluded from stock market index, researchers

have found some changes in stock prices, trading volumes, volatility, bid-ask spread of included or excluded stocks and they have

proposed various explanations regarding this uncharacteristic change. Though there are several explanations but current research

in this area suggests six important explanations (hypotheses) to explain the reasons for the changes in stock prices and trading

volumes of the included or excluded stocks around the revision dates. Those are – Downward Sloping Demand Curve (DSDC)

(proposed by Shliefer in 1986) or Imperfect Substitution Hypothesis, Price Pressure Hypothesis, Liquidity Hypothesis,

Information Content Hypothesis, Investor Awareness Hypothesis and The Selection Criteria Hypothesis. All the explanations of

the effects of stock addition and deletion are of mainly two types: (i) a demand-based explanation; and (ii) an information-based

explanation. The demand-based explanation sees index changes as information-free events whereas information based explanation

states index changes convey information about the company. Demand-based explanation includes Imperfect Substitute

Hypothesis, Price Pressure Hypothesis, Investor Recognition Hypothesis and Information-based explanation includes Information

Hypothesis, Liquidity Hypothesis and The Selection Criteria Hypothesis.

All the hypotheses are briefly discussed below:

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3.1 Imperfect Substitute Hypothesis or Downward Sloping Demand Curve Hypothesis:

This hypothesis is proposed by Shliefer in 1986 and it states that the securities are not close substitutes and the demand is

less than elastic. So, the demand curve is downward. According to this hypothesis demand curve shifts to eliminate excess

demand and the equilibrium price will change. If there is an increasing (decreasing) demand of a particular security then the price

will go up (or down) to reach a new equilibrium. Price reversals are not expected as the new price is also the new equilibrium

price. If we try to explain the impact of stock inclusion to or stock exclusion from a stock market index we can expect a

permanent price increase (decrease) for the included (excluded) stock.

3.2 Price Pressure Hypothesis:

The Price Pressure Hypothesis states that investors who enable demand shifts need to be compensated for the transaction costs

and portfolio risks that they carry when they accept to purchase or sell shares which they otherwise would not trade (Harris,

1986). There should be a price increase (or decrease) in relation to the increased purchasing (or selling of any particular stock.

The hypothesis recognizes that information about non-information motivated shift in demand may come at a cost. It says that in

case of large purchase of a security the liquidity suppliers are attracted by the increase in price and, therefore, trade initiated by

the buyers will come at a premium. In contrary, in case of large sale of a security the liquidity suppliers are attracted by the

decrease in price and, therefore, trade initiated by the sellers will come at a discount. But this price effect is temporary and price

reversal will also follow.

3.3 Liquidity Hypothesis or Information Cost Hypothesis:

Stocks with low liquidity have greater bid-ask spreads which increases transaction costs. An investor who wants to trade can

either wait to buy or sell his stocks at a beneficial price or he / she can choose to execute the transaction immediately at the

current bid or ask price. In the second case bid price includes a premium and the ask price will be at discounted price. Liquidity

Hypothesis predicts that stocks with improved liquidity will reduce bid-ask spread as a result trading cost will decrease. It also

states that acquiring information of a stock with less available information is a costly process and the securities having less

information involved with a higher systematic risk. When a stock is included into an index, the amount of the available

information will increase due to the greater coverage by media, analysts and new investors. As a result information asymmetry

will decline, liquidity will increase (bid-ask spread will decrease) and reduces total trading costs. When a stock is excluded from

an index the logics are just opposite to the index inclusion. As per this hypothesis we see a permanent increase in both stock price

and trading volume in case of an index inclusion and the opposite for index exclusion.

3.4 Information Content Hypothesis: It suggests that announcements of changes in the index contain nonpublic information and that stock prices change after the

market incorporates this information. The hypothesis predicts permanent price effects on both additions to and deletions from the

index. Included firms can be considered as industry leader and the quality of management improves substantially after the

inclusion.

3.5 Investor Recognition Hypothesis or Investor Awareness Hypothesis or Attention Hypothesis: It argues that inclusion of a stock to the index enhance the investors’ awareness about the stock i.e. the investors recognize the

stock and their attention to that particular stock increases. It also suggests that asymmetric price changes between sub groups of

additions can be explained by asymmetric changes in investor recognition. It explains the permanent price increases for additions

and the temporary price decreases for deletions by the changes in investor recognition.

The price revaluations for new additions (companies added to the index for the first time) is greater and permanent due to

significant changes in investor recognition, whereas those for upward additions (companies moved to an index from the lesser-

known indices) and re-entry additions (companies previously deleted from and later re-added to the index) are weaker and

temporary owing to insignificant changes in investor recognition; and no significant difference exists between pure deletions

(companies dropped from the S&P index family altogether) and downward deletions (companies moved to lesser-known indices)

in either magnitude or duration of price effects owing to an insignificant decrease in investor recognition for both subgroups.

3.6 The Selection Criteria Hypothesis: It states that changes in stock prices and volumes of stock inclusion or deletion can be

explained partly by the criteria upon which the sample of stocks is selected. Because the indices have declared and publicly

available inclusion criteria and those are on the basis of recent past performances. So, if the stocks are selected on the basis of

performance in the previous period it is more likely to say that they will perform in the same way in the subsequent period after

inclusion in the index [Bechmann (2002)]. This found support in some studies despite most index management committees

(including S & P index committee) affirming that the inclusion (exclusion) isn’t any verdict on the investment attractiveness or

the future prospects of the stock.

Each hypothesis attempts to explain the causes and durations of abnormal returns as well as the impact on trading volume for the

included or excluded stock in the index and the hypotheses are not mutual exclusive.

Table – 1: Inclusions and Exclusions of Stocks in the Index and its expected effect on Price and Volume under different

Hypotheses

Hypothesis Expected effect of inclusion on Expected effect of exclusion on

Price Volume Price Volume

1. Imperfect Substitute

Hypothesis

Permanent

increase

Temporary increase but

permanent increase or decrease

Permanent

decrease


permanent increase or decrease

2. Price Pressure

Hypothesis

Temporary

increase

Temporary increase Temporary

decrease

Temporary increase

3. Liquidity Permanent Permanent increase Permanent Permanent decrease




Hypothesis increase decrease

4. Information Content

Hypothesis

Permanent

increase

Permanent increase Temporary

decrease


permanent decrease

5. Investor

Recognition

Hypothesis

Permanent

increase

No clear indication No effect No clear indication

6. Selection Criteria

Hypothesis

Permanent

increase

Permanent increase Permanent

decrease

Permanent decrease

Objectives of the Paper: The paper attempts to review the findings of the various researchers from the different countries of the

world till date. It will help the investors, fund managers, arbitrageurs to understand the effect of index revision on stock prices and

also help them to take correct investment decision at the time of index composition change.

Literature Review: There are a considerable number of literatures on the effect of stock inclusion to or deletion from stock

market index considering the data from various countries of the world. The majority of the studies are undertaken using the data

from American Stock Market and particularly the S&P 500. I have reviewed the literatures from 24 countries viz. USA, Japan,

New Zealand, Canada, Italy, Germany, Australia, UK, Denmark, Portugal, Pakistan, Netherlands, France, Singapore, Hong Kong,

India, Turkey, Sweden, China, Korea, Malaysia, South Africa, Egypt and Greece and the findings are summarized below:

Table – 2: Summary of Selected Previous Studies that examine the effects of stock inclusion to or exclusion from index

1. Author(s)

2. Index (Country)

3. Period of Study

1. No. of Events

2. Focus of Study

1. Findings

2. Supported Hypothesis

1. Shleifer (1986)

2. S & P 500 (USA)

3. 1966 – 1983

1. 246 additions

2. Price and volume effects

of stock additions to the

index

1. Significant positive abnormal return for the included stocks at the

announcement of the inclusion and this return does not disappear for at

least ten days after the inclusion. The returns are positively related to

measures of buying by index funds, consistent with the hypothesis that

demand curves for stocks slope down.

2. Imperfect Substitute Hypothesis

1. Harris & Gurel

(1986)

2. S & P 500 (USA)

3. 1973 – 1983

1. 194 additions and 13

deletions


of stock additions and

deletions to the index

1. Increase in price immediately after an addition is announced and this

price increase is nearly fully reversed after 2 weeks. There is a large

increase of volume on the first trading day after the announcement of

addition.

2. Price Pressure Hypothesis

1. Arnott & Vincent

(1986)

2. S & P 500 (USA)

3. 1980 – 1984


deletions

2. Price effects of stock

additions and deletions to

the index

1. Permanent increase or decrease in stock prices in case of additions

or deletions respectively


1. Jain (1987)

2. S & P 500 (USA)

3. 1977 – 1983


deletions

2. Price effects of stock

additions and deletions to

the index

1. Significant price movements associated with the additions and

deletions.

Mean excess return for included stocks is positive and mean excess

return for excluded stocks is negative on the announcement date.

2. Information Signaling Hypothesis

1. Dhilon & Johnson

(1991)

2. S & P 500 (US)

3. 1978 - 1988

1. Additions of 187 stocks

and 41 calls & 33 puts

options

2. Price (stocks and

options) and Volume

effects of additions to the

index

1. Permanent increase of stock prices, Price increases for call options

and price falls for put options.

Permanent increase in trading volume

2. Information Signaling Hypothesis & Imperfect Substitute

Hypothesis

1. Lynch &

Mendenhall (1997)

2. S & P 500 (US)

3. 1990 – 1995


deletions

2. Stock price effects with

the change of index

composition

1. Positive abnormal return during the period after the announcement

and before the effective change, Negative abnormal return after the

effective change.

Significant negative permanent price effect for deletion.

Significantly positive abnormal volume for six consecutive days

starting from the announcement day.

2. Imperfect Substitute Hypothesis or Downward Sloping Demand

Curve Hypothesis & Price Pressure Hypothesis

1. Liu (2000)

2. Nikkei 500

(Japan)

3. 1991 – 1999


deletions

2. Price and Volume

effects after announcement

of changes in index

1. Significant price increase (or decrease) for stocks added (or deleted)

and no significant price reversal.

Significant increase of trading volume in short-run for both addition

and deletion but trading volume significantly falls (rises) for stocks

added (deleted)




composition 2. Downward Sloping Demand Curve Hypothesis or Imperfect

Substitute Hypothesis

1. Li et al. (2000)

2. NZSE 10 &

NZSE 40 (New

Zealand)

3. 1994 – 1998


deletions (NZSE 10)

14 additions19 and

deletions (NZSE 40)

2. Price effects to the

changes of index

composition

1. No significant index effect of additions or deletions for NZSE 10

Market is efficient for additions in NZSE 40 are concerned and no

opportunity for making speculative profit

2. Liquidity Hypothesis, Price Pressure Hypothesis & Information

Hypothesis

1. Masse et al.

(2000)

2. TSE 300

(Canada)

3. 1984 – 1994


deletions

2. Price effects

1. When the addition and announcement are done on the same day

(before 1989) included stocks give positive price response with the

largest effect on the first trading day after the event. Market reacts

positively even when announcement was made prior to inclusion.

No significant effects for deleted stocks.


1. Rigamonti &

Barontini (2000)

5. Mib 30 & Midex

(Italy)

3. 1995 – 1999


deletions (Mib 30)

14 additions and 16

deletions (Midex)


1. Included stocks in Mib 30 before the creation of Midex give

significant excess return over the period before the announcement to

the day before the effective change and later price reversal occurs. This

temporal price increase attributed to the rebalancing activity of fund

managers and index arbitrageurs. Significant price decrease for

deletion over the post announcement period and it persists.

Trading volume is exceptionally high over the post announcement

period and on the change date but after the change date gradually it

comes to normal level.

After the creation of Midex, stocks included in Mib 30 gives persistent

abnormal negative return and excluded stocks show temporary price

pressure.

Significant abnormal positive return for stocks included in the Midex

and significant abnormal negative return for stocks excluded from the

Midex which do not revert.

2. Price Pressure Hypothesis, Information Hypothesis.

Liquidity Hypothesis for included stocks only.

1. Deininger et al.

(2000)

2. DAX, MDAX

(Germany)

3. 1988 – 1998


deletions (DAX)

4 16 additions and 18

deletions (MDAX)

44 events for calculation of

volume effects

2. Price and Volume

Effects

1. Strong abnormal price impact on the announcement date. Included

stocks give positive abnormal return and excluded stock give negative

abnormal return on the announcement date though there is significant

price increase for excluded stocks during the period from

announcement date to replacement date. No indication of price

reversion.

Abnormal trading volumes are larger and more significant for index

inclusion.

2. Imperfect Substitute Hypothesis, Liquidity Hypothesis

1. Chan & Howard

(2002)

2. All Ordinaries

Index (Australia)

3. Jan. 1992 – Jul.

1998


deletions

2. Price and volume effect

1. Significant positive (or negative) abnormal returns immediately

prior to addition (or deletion) and evidence of price reversals on the

date of change.

Excessive trading volume close to the change date


1. Wurgler &

Zhuravskaya (2002)

2. S & P 500 (US)

3. 1976 – 1989

1. 259 additions

2. Price Effects of stock

additions

1. Arbitrage risk is an important determinant of the demand curve’s

slope and this risk discourages arbitrage from flattening demand curves

for stocks.


1. Beneish &

Whaley (2002)

2. S & P 500 (US)

3. 1996 – 2001


deletions


1. Abnormal returns surrounding the announcement date and abnormal

trading volume on the effective day.

Enormous growth of index fund is responsible for such a greater price

reaction.


1. Mase (2002)

2. FTSE 100 (UK)

3. 1992 – 1999


deletions

2. Long term performance

of included and excluded

stocks, short term price and

volume effects around the

announcement and event

1. The analysis of long-run performance yields three-year buy-and-

hold abnormal positive or negative returns (measured from 21 days

after the event date) for stock additions or deletions. These long-run

abnormal returns reflect the impact of increased (reduced) investor

interest in additions (deletions), possibly as a result of index tracking.

The analysis of short-run returns and volume around the event

indicates short term price pressure prior to changes in the constituents




dates of included and

excluded stocks as well as

the stocks which are just

fail to be included or just

avoid being deleted.

of the FTSE 100 Index, both for additions and deletions.

2. Price Pressure Hypothesis, Investor Awareness Hypothesis

1. Hyland & Swidler

(2002)

2. NZSE40 (New

Zealand)

3. 1991 – 1999

1. 22 additions

2. Price and Volume

effects for stocks addition

1. Addition of stocks in the index raises investors’ awareness about the

company. Consequently increases the informational efficiency and

lower the cost of capital and hence evidence of permanent increase in

stocks prices and trading volume

2. Attention Hypothesis

1. Jog & Okumura

(2003)

2. TSE 300

(Canada)

3. 1991 – 2000

1. 152 inclusions and 144

exclusions

2. Short term and long term

returns as well as trading

volume of included and

excluded stocks

1. For included stocks both prices and volumes increase before the

actual inclusion and after the actual inclusion price level decreases but

remains at higher level. For excluded stocks there is significant price

decrease and volume increase before the implementation and after the

actual exclusion the price and volume reverts to the pre-exclusion

level.

2. Downward Sloping Demand Curve Hypothesis or Imperfect

Substitute Hypothesis

1. Hanaeda & Sarita

(2003)

2. Nikkei 225

(Japan)

3. April 2000


deletions

2. Price and Volume

Effects

1. Newly included firms recorded significant positive excess return in

the five day period after announcement of change. Excluded and

remaining firms’ returns negatively affected.

Significant increase in trading volume for both included and excluded

stocks.


1. Bechmann (2004)

2. KFX (Denmark)

3. 1989 – 2001


deletions

2. Price and Volume

Effects

1. Significant negative abnormal return for deleted stocks in a six

month period before the deletion and a decrease in trading volume and

efficiency of stock prices after the deletion.

Positive abnormal return for included stocks in a six month period

before the inclusion and there is no significant effect on trading volume

and efficiency of stock prices after the inclusion.

2. Imperfect Substitute Hypothesis, Information Cost / Liquidity

Hypothesis, Selection Criteria Hypothesis

1. Biktimirov et al.

(2004)

2. Russell 2000 (US)

3. 1991 – 2000

1. 4231 additions and

3092 deletions

2. Price, Volume and

Institutional Ownership

Effects

1. Significant price increase with abnormally high trading volume

around the reconstitution date and increase in institutional ownership

for included stocks.

Significant price decrease with abnormally high trading volume around

the reconstitution date.

Both price and volume effects are temporary


1. Duque & Madeira

(2004)

2. PSI 20 (Portugal)

3. 1996 – 2001


deletions

2. Effects on stock price,

trading volume and

volatility

1. Stock price reacts positively for addition and negatively for deletion

during the time period between announcement day and the day of

effective change. Price decreases significantly on the effective date of

change for included stocks which is the indication of overreaction after

the announcement.

Positive abnormal trading volume for included and excluded stocks

and it persists at least 15 days after the event.

No statistically significant volatility is observed.

2. Price Pressure Hypothesis and Liquidity Hypothesis

1. Chen et al. (2004)

2. S & P 500 (US)

3. 1962 – 2000


deletions

2. Price and Volume

Effects

1. Asymmetric price effect around additions to or deletions from S & P

500 due to changes in investor awareness and the consequent effect on

investor behaviour. Permanent increase in the price for added firms but

no permanent price fall for deleted firms.

2. Investor Awareness Hypothesis

1. Chakrabarti et al.

(2005)

2. MSCI (Multi-

country)

3. 1998 – 2001

1. 455 additions or

deletions

2. Price and Volume

Effects

1. For included stocks, sharp rise in price after the announcement and a

further rise before the actual change but part of the gain is lost after the

actual change and significant increase in trading volume and it remains

high even after the actual change. For excluded stocks steady and

remarkable price decline. Considerable cross-country variations of

these effects are found.


1. Ameer (2005)

2. KSE 100

(Pakistan)


deletions

2. Price effects

1. Included stocks with lower level of beta give significant cumulative

abnormal return but no significant cumulative abnormal return for the

stocks with high beta. KSE attracts passive investors rather an active




3. 2000 – 2002 investor.

2. No support to any hypothesis

1. Doeswijk (2005)

2. AEX

(Netherlands)

3. 1994 – 2001


deletions

2. Short term price and

volume effects

1. Included stocks witness an outperformance in the weeks before the

revision, while excluded stocks are unaffected. There are indications of

temporary price pressure for winners as well as losers around the

revision day.

2. Attention Hypothesis, Price Pressure Hypothesis

1. Chen et al. (2006)

2. S & P 500,

Russell 2000 (US)

3. 1989 – 2002

1990 – 2002


deletions

7244 additions and 4969

deletions

2. Effect on Index

Tracking Funds

1. Index fund investors lose a significant amount due to the

predictability and timing of index changes and fund managers’

objective of minimizing tracking error and it creates an opportunity to

the arbitrageurs.


1. Gregoriou &

Ioannidis (2006)

2. FTSE 100 (UK)

3. 1984 – 2001


deletions


1. Significant gain to shareholders of firms added Index and added

firms experience an increase in trading volume. The reverse results

hold for deletions.

An increase in the ‘quantity’ of available information and a decrease in

future trading costs after the change.

2. Information Cost / Liquidity Hypothesis

1. Vespro (2006)

2. CAC 40, SBF 120

(France), FTSE 100

(UK)

3. 1997 – 2001


deletions (CAC 40 & SBF

120)

23 additions and 28

deletions (FTSE 100)

2. Price and Volume

Effects

1. Share price overreact to non-information and price reversal is

observed after the effective change.

Volumes increase permanently for included stocks.


1. Liu (2006)

2. Nikkei 225

(Japan)

3. 1970 - 2002


deletions


1. Evidence of the permanent price effects for both additions and

deletions and cumulative abnormal volumes for both cases.


1. Docking and

Dowen (2006)

2. S & P 600 Small

Cap (US)

3. 1999 – 2002

1. 181 pure additions and

30 downward shift

173 pure deletions and 50

upward shift on the

Announcement Date (95

pure deletions and 50

upward shift on the Change

Date)

2. Price effects

1. An overall significant positive abnormal return reaction on the

effective announcement date and that partially reverses during the post-

change day period for pure additions. An overall significant negative

abnormal return reaction on the effective announcement date and that

completely reverses on the effective change day for pure deletions.

Arbitrage opportunities may exist between the announcement date and

change date because index fund managers attempt to minimize tracking

error.


1. Gowri Shankar &

Randhawa (2006)

2. Straits Times

(Singapore), Hang

Seng (Hong Kong)

3. 1998 – 2004

(Straits Times)

1990 – 2004 (Hang

Seng)


deletions (Straits Times)

33 additions and 33

deletions (Hang Seng)


1. Significant positive returns (decline in prices) for the stocks added to

(stocks deleted from) on the announcement date and these returns are

subsequently reversed within 10 days after the effective day. Abnormal

trading volume around the announcement and effective days, but revert

to normal in the post-effective day period. For STI additions, no

significant reaction on the announcement day; and in the subsequent

periods also, the returns are not substantial.


1. Qiu & Pinfold

(2007)

2. ASX 100 & ASX

300 (Australia)

3. 2000 – 2003


deletions (ASX100)

68 additions and 72

deletions (ASX 300)


1. No abnormal returns for additions to or deletions from the S&P/ASX

100 and only a weak effect for additions to or deletions from the

S&P/ASX 300.

Small but statistically significant increase in trading volume for stocks

added to the index on both the announcement and implementation

dates and deletions from the index show no significant changes in

trading volumes on either the announcement or implementation dates.

2. No support of any hypothesis

1. Kumar (2007)

2. Nifty & Jr Nifty

(India)

3. 1996 – 2003

1. 23 announcement events

and 33 effective change for

Nifty additions and 18

announcement events and

28 effective change for

1. Stock prices increase (decrease) significantly on the effective day for

the Nifty index both for additions (deletions) and no such effects were

observed for Jr. Nifty index. The prices revert after around a week's

time for both cases. But no abnormal volumes were detected around

the effective day.




Nifty deletions

51 announcement events

and 54 effective change for

Nifty additions and 27

announcement events and

30 effective change for

Nifty deletions



1. Mase (2007)

2. FTSE 100 (UK)

3. 1992 – 2005


exclusions


1. Temporary abnormal returns for both additions and deletions.

Increase in trading volume before the effective date confirms the short

term buying or selling pressure.


1. Mazouz &

Saadouni (2007)

2. FTSE 100 (UK)

3. 1984 – 2003


deletions (price data)


deletions (volume data)

75 additions and 78

deletions (closing bid-ask

price data)

2. Price and Volume

Effects

1. Both additions and deletions experience permanent price change.

Added (removed) stocks exhibit permanent (temporary) change in

trading volume and bid-ask spread.

2. Imperfect Substitute Hypothesis,

1. Mazouz &

Saadouni (2007)

2. FTSE 100 (UK)

3. 1984 – 2003


deletions (price data)


deletions (volume data)

2. Short and long term

price effects

1. The observed positive (negative) abnormal returns associated with

the added (deleted) stocks in the pre-announcement period suggests

that information about the index revision are incorporated into the

stock price before the announcement date and these returns reverses

completely nearly in less than two weeks after the effective change

date.

The highest (lowest) abnormal return in the sample of the included

(excluded) stocks together with the highest volume ratio are found on

the day prior to the effective index revision date.


1. Cai (2007)

2. S & P 500 (US)

3. 1976 – 2001

1. 427 additions


of additions

1. Firms added to the S&P 500 react positively to the announcement

and added stocks experience a sharp increase in trading volume around

both announcement date and effective change date.

Industry and size matching stocks of the added stocks also have

significantly positive price reaction but the trading volume of these

matching stocks does not increase.

2. Information Content Hypothesis

1. Bildik & Gulay

(2008)

2. ISE 100, ISE 30

(Turkey)

3. 1995 – 2000 (ISE

100)

1997 – 2000 (ISE

30)


exclusions (ISE 100)

27 inclusions and 27

exclusions (ISE 100)


1. Stocks included in (excluded from) the index, particularly for the

ISE-30, tend to generate positive (negative) abnormal returns in the

event period, and trading volume and volume volatility are also

significantly affected by the event. Abnormal returns are statistically

weak in parametric tests but statistically significant in non-parametric

tests.

2. Price Pressure Hypothesis, Imperfect Hypothesis and Attention

Hypothesis

1. Andelius &

Skrutkowski (2008)

2. OMXS 30

(Sweden)

S&P Euro+, FTSE

Nordic 30,

Eurostoxx 600 and

FTSE Eurotop 300

(Europe)

3. 1987 - 2006

1. 129 additions to

domestic index and 65

additions to overseas

indices

2. Effects of inclusion in

the domestic index as well

as overseas indices of

Swedish stocks

1. Statistically insignificant and mildly negative abnormal returns are

found for index inclusion in the Stockholm Stock Exchange. The

negative effect is more pronounced and statistically significant for

inclusions in overseas indices and these negative cumulative abnormal

returns reach a climax on day 4 after index inclusion. No statistically

significant higher trading volumes on or around the event day of index

inclusions.

2. No support to any hypothesis relating to stock inclusion or exclusion

but supports Efficient Market Hypothesis

1. Liu (2009)

2. Nikkei 225

(Japan)

3. 1975 – 2006


deletions

2. Impacts of index

membership on stock

pricing efficiency and

stock return predictability

1. Improved information environment for the included stocks improve

their pricing efficiency and lower return predictability.





1. George (2009)

2. S & P CNX Nifty

(India)

3. 2004 – 2006


exclusions

2. Price reactions to index

reorganization

1. No statistically significant price reaction of inclusion and exclusion

of stocks in S & P CNX Nifty

2. Do not support any hypothesis of index constituent changes but

supports Efficient Market Hypothesis

1. Li & Sadeghi

(2009)

2. S & P/CITIC

(China)

3. 2003 – 2007

1.69 inclusions and 69

exclusions

2. Price and liquidity

effects

1. Cumulative abnormal returns are negative (positive) before the event

day for included stocks (excluded stocks), then start to increase

(decrease) for several days after the event day. Significant negative

(positive) cumulative abnormal return prior to addition (deletion) may

be due to the flow of false information from informed syndicate

speculators to uninformed investors.

For included stocks, significant increase in the bid–ask spread before

the event and a decline after the event, while the volume of trade

showed significant increases before and after the event. For excluded

stocks, the volume of trade increases without significant change in the

bid–ask spread.

2. Information Hypothesis

1. Parthasarathy

(2010)

2. Nifty (India)

3. 1999 – 2010

1. 38 inclusions


of stocks addition

1. Permanent abnormal returns subsequent to announcement and

inclusion date but there is limited evidence for permanent abnormal

volume.

2. Information Hypothesis, Investor Awareness Hypothesis

1. Hrazdil (2010)

2. S & P 500 (US)

3. 1987 – 2004

1. 78 inclusions

2. Validity of Information

Hypothesis of S & P 500

index inclusion

1. S&P committee reveals no new information in their announcements

to include a firm in the S&P 500 index or S&P may implicitly

incorporate a small amount of information about firms’ future

performance; but if so, such information plays only a negligible role in

selecting the new index members.

2. No support to Information Hypothesis

1. Yun & Kim

(2010)

2. KOSPI 200

(Korea)

3. 1995 – 2008


exclusions


1. In the more recent period there is some evidence of permanent price

effects but no full return reversal found. Trading volumes tend to

significantly increase after the announcement date and remain

relatively higher than before the event. Anticipatory trading effect

exists before the effective dates, but this trading has no predictive

power for future return.

KOSPI 200 index changes convey favorable information on added

stocks and unfavorable information on deleted stocks.

2. Information Hypothesis

1. Zhou (2011)

2. S & P 500 (US)

3. 1962 – 2008

1.364 inclusions (169 new

additions and 195 upward)

and 107 exclusions (74

pure deletions and 33

downward) (1991 – 2008)

876 new-entry and 52

reentry additions (1962 –

2008)

2. Price effects

1. Price increase for pure and new-entry additions are permanent but

the price increase for upward and reentry additions are temporary.

Price effects for both pure and downward deletions are temporary.

Pure and new-entry additions acquire more share holders, experience a

greater decrease in Merton's shadow cost, and have a greater increase

in analyst coverage after the additions. Pure deletions lose more

shareholders and analyst coverage and have a greater increase in

shadow cost than do downward deletions.

2. Investor Recognition Hypothesis

1. Gregoriou (2011)

2. CAC 40 (France)

3. 1997 – 2001


exclusions

2. Liquidity effects

1. Additions (deletions) of stocks witness a long-term enhancement

(reduction) in the liquidity of CAC40 stocks and a significant decrease

(increase) in bid–ask spreads in the post-index revision trading period.

Change of the effective bid–ask spread shows a significant change in

the relative direct cost of transacting. The permanent rise (fall) in

liquidity as a result of index additions (deletions) could result in

increasing (decreasing) firm value.

2. Liquidity Hypothesis

1. Schmidt et al.

(2011)

2. S & P/ASX 200

(Australia)

3. 2000 – 2009


exclusions


1. Additions (deletions) to the S&P/ASX200 experience positive

(negative) abnormal returns on announcement dates that increased

further on a cumulative basis up to implementation dates, after which

abnormal returns began to reverse. Our study found also that trading

volume increased substantially on announcement dates and remained

abnormally high until implementation date.


1. Selvam et al.

(2012)

2. S & P CNX Nifty

(India)


exclusions

2. Impact on stock price

and volatility

1. Nifty experiences negative returns during the pre- and post-

announcement period, so investors could not earn excess returns on

announcement day as well as effective day from stock inclusion or

exclusion in CNX Nifty index.




3. 2005 – 2009 No impact on the volatility of the companies included and excluded in

Nifty on announcement day and effective day but there is high

volatility in the share price around the day of inclusion and exclusion.


1. Chan et al. (2013)

2. S & P 500 (US)

3. 1962 - 2003


exclusions


including changes in

institutional ownership,

liquidity, analyst coverage,

and investor recognition.

1. A significant price increase for added stocks in the short run and in

the five-year period after addition. There is an initial price decline for

deleted stocks after their deletion from the index and deleted stocks

outperform the market in the long run.

For added stocks, there are increases in institutional ownership and

liquidity, a decline in shadow cost, and a long-term increase in analyst

coverage. For deleted stocks, there is a decline in analyst coverage, an

increase in liquidity, but no significant long-term effects on

institutional ownership and shadow cost.

2. Imperfect Substitute, Liquidity and Information Hypothesis

1. Cheung & Roca

(2013)

2. DJSWI (Asia

Pacific Countries)

3. 2002 – 2010


exclusions

2. Impact on returns, risk

and liquidity

1. Negative and statistically significant abnormal returns for both

added stocks and deleted stocks after the announcement day and there

is an evidence of a price reversal a week after the day of change. Both

included and excluded stocks experience an increase in trading volume,

but the increase in trading volume for excluded stocks seems to be

more significant but the enhanced trading volume for deleted stocks is

a temporary one. Bid–ask spread is generally smaller in size after the

announcement day, regardless of types of stocks and this becomes

wider later after the day of change.

2. No support to any hypothesis but support redundancy hypothesis as

developed by them.

1. Biktimirov & Li

(2014)

2. FTSE Small Cap

(UK)

3. 1998 – 2008


deletions

2. Price and Volume

Effects

1. Firms promoted from a smaller-cap to a larger-cap experience a

permanent increase in stock price accompanied by improvements in

liquidity. Similarly, firms demoted from a larger cap to a smaller-cap

experience a permanent decrease in stock price accompanied by

declines in liquidity. In contrast, newly added firms experience a

transitory stock price gain and declines in liquidity. Stock price

reaction is due to significant increase in institutional ownership and the

decline in liquidity is due to the decrease in the percentage of free float

shares for these stocks.

2. Liquidity & Price Pressure Hypothesis

1. Rahman & Rajib

(2014)

2. S & P CNX Nifty

(India)

3. 1998 – 2011


deletions


1. The price and volume effect is less on the announcement date and

more on the effective date for inclusions and as well as for exclusions.

Probable reason of this may be the index fund managers are

concentrating less on the announcement date in compared to the actual

change day. There is no evidence of permanent price effect, but there

were short term price reversals.


1. Azevedo et al.

(2014)

2. KLCI (Malaysia)

3. 2005 – 2012


deletions


1. Evidence of significant abnormal returns for both stocks additions

and stocks deletions and the effect is robust for stock deletions but the

stock prices reverse to the preannouncement level. Liquidity changes in

a significant manner as a result of the news of index composition

change.


1. Wang et al.

(2015)

2. CSI 300 (China)

3. 2005 - 2012


deletions

2. Price and Volume

Effects

1. The temporary nature of the abnormal stock returns during the five

trading days after the announcement is consistent with a temporary

change in demand, possibly induced by market participants, including

index funds, attempting to track the index and significant price

reversals for both CSI 300 Index additions and deletions are observed.

An analysis of the trading volume around the event shows the pattern

in abnormal stock returns is driven by short-term buying (or selling)

pressure and this buying (selling) pressure is associated with an

increase in trading volume or stock liquidity after the announcement

date.


1. Kot et al. (2015)

2. Hang Seng (Hong

Kong)

3. 1986 – 2008


deletions


of stocks additions to and

1. The stocks newly deleted from the Hang Seng Index have abnormal

returns over a 5-year holding period and the newly added stocks show

no abnormal returns. The deleted stocks outperform the added stocks,

with the difference resulting from poorly performing state owned




deletions from Index added stocks and better performing family-owned deleted stocks.

Deletion from the Hang Seng Index does not provide new and

unfavorable information about a firm and the results are consistent with

the finding that family-owned firms outperform non-family owned

firms.


1. Miller & Ward

(2015)

2. FTSE / JSE

Indices (South

Africa)

3. 2002 - 2011


deletions

2. Price Effects

1. Prices of the included/excluded stocks during the pre-event window

for all indices show statistically significant increase/decrease.

In the post event window the results show shares entering the index

underperform whereas those leaving the index out-perform though

these findings were not significant for all of the indices examined.


1. Yu et al. (2015)

2. Nasdaq 100 (US)

3. 1994 – 2009

1. 256 additions

2. Impact of additions on

price, trading volume, bid-

ask spreads and operating

performance

1. Positive returns upon announcement of the addition are documented

and Market liquidity is enhanced after the announcement of addition.

Bid/ask spreads of added stocks are narrower but no evidence of

significant effects of enhanced managerial effort or operating

performance associated with the inclusion.

2. Liquidity Hypothesis

1. Fernandes &

Mergulhão (2016)

2. FTSE 100 (UK)

3. 1992 – 2010


deletions

2. Price and Volume

Effects

1. The impact of index composition changes is stronger in the pre-

event window, though anticipatory trading responds for a substantial

part of these pre-announcement effects. After the announcement no

evidence of any price reversal and hence the price impact is permanent

and these findings imply that the demand curve for stocks is downward

sloping.


1. Ng & Zhu (2016)

2. FTSE Bursa

Malaysia EMAS

Shariah Index

(Malaysia)

3. 2007 – 2014


deletions

68 additions and 33

deletions


1. Stock prices increase for included stocks, while exclusions lead to a

decrease in stock prices, both temporarily and permanently. Index

inclusions and exclusions lead to an increase in the short term and long

term stock trading volumes.

2. Price Pressure Hypothesis, Imperfect Substitute Hypothesis

1. Yildiz & Dia-

Eddine (2016)

2. Participation – 30

Index (Turkey)

3. 2011 – 2015


deletions

2. Impacts on stock returns

and trading volumes

1. Stock prices respond negatively to the index additions and positively

to the index deletions in general but on the announcement and effective

days, negative returns are found both for index additions and deletions.

Trading activity of added and deleted stocks is affected positively in

the announcement day; while the effective day exhibits an exact

opposite behaviour.


1. Bodhanwala &

Bodhanwala (2016)

2. CNX Nifty

(India)

3. 2005 – 2015


deletions

2. Long term return effects

1. Returns of portfolio of shares excluded and portfolio of shares

included are not significantly different. On the effective change date,

the stock to be included is overvalued and hence the future returns are

poor but after exclusion, the excluded stock is undervalued and hence

generates better returns in future.


1. Ahmed &

Bassiouny (2017)

2. EGX 30 (Egypt)

3. 2005 – 2015


deletions

2. Price, volume and

liquidity effects

1. Added stocks experience a significant increase in price, volume and

liquidity during the period from the announcement to change date of

the index constituents. Increase in volume for added stocks in the run

up window is not reversed in the post change period Deleted stocks

indicate an asymmetric effect where an insignificant effect on price and

liquidity but a significant effect on volume levels during the post

change window.

2. Downward Sloping Demand Curve Hypothesis, Investor Awareness

Hypothesis

1. Papachristou et al.

(2018)

2. FTSE ASE 20

(Greece)

3. 2000 – 2012


deletions


1. Exclusion from the index can be considered as a source of abnormal

negative returns and that this exclusion matters more than inclusion to

investors. Investment strategies on the basis of news of exclusion from

the index can lead to the higher performance of investors.

2. Downward Sloping Demand Curve Hypothesis

Discussion and Conclusion: A large number of studies have been conducted to find out the effect of index revision in various

countries and their studies cover different study period. The studies are not only on the large cap indices it extended to mid cap

and small cap indices as well. These vast numbers of literatures have considered various aspects of index revision but their results

and conclusions differ widely. Majority of the studies have found abnormal return of included and excluded stocks but some




studies do not support this. Researchers who have found abnormal returns disagree whether these abnormal returns are permanent

or temporary and they give different explanations. The reasons of this controversy may be summarized as below:

Firstly, Stock markets of different countries differ on many dimensions, e.g., size, liquidity, trading volume, market mechanisms,

informational efficiency, accounting standards, securities regulations, investor protection, investors’ behaviour, and corporate

governance. Share market indices of different countries can also differ in terms of features such as format (open or closed end),

the eligibility criteria for inclusion, the frequency of index revision and the time gap between announcement and effective

changes, if any. Some time it differs index to index in same country. Some studies are conducted in developed markets, some in

the emerging markets and some in the less mature and small markets. Less mature and under-developed stock markets have less

informational efficiency, higher costs, smaller investor base and lower liquidity compared with the stock markets of developed

countries.

Secondly, almost all the empirical studies all over the world follow the event study methodology. As there is no hard and

fast rule for selecting the number of days for an event window, different researchers have used different time periods to test the

effects of index revision.

Thirdly, the relative size of the index fund is a key determinant of price and volume effect because the index fund

managers rebalance their portfolio immediately after the index revision to minimize the tracking error. All countries do not have

same relative strength of index funds even this relative strength changes over time for a particular country also.

Fourthly, macro economic conditions of different countries are not same even it differs in different time periods which

affect the price and volume.

Finally it can be concluded that the investors, speculators and arbitrageurs who track the stock market index should

cautious while investing and should not be taken the index revision as sole criteria for an aggressive investment decision.

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