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Strategic trading by index funds and liquidity provision around S&P 500 index additions

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  • Green, T. Clifton
  • Jame, Russell
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    Abstract

    We examine the trades of index funds and other institutions around S&P 500 index additions. We find index funds begin rebalancing their portfolios with the announcement of composition changes and do not fully establish their positions until weeks after the effective date. Trading away from the effective date is more prevalent for stocks with lower levels of liquidity and among large index funds, which is consistent with index funds accepting higher tracking error in order to reduce the price impact of their trades. Small and mid-cap funds provide liquidity to index funds around additions, and added stocks with a greater proportion of these natural liquidity providers experience lower inclusion returns.

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    File URL: http://www.sciencedirect.com/science/article/pii/S1386418111000140
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Markets.

    Volume (Year): 14 (2011)
    Issue (Month): 4 (November)
    Pages: 605-624

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    Handle: RePEc:eee:finmar:v:14:y:2011:i:4:p:605-624

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    Web page: http://www.elsevier.com/locate/finmar

    Related research

    Keywords: S& P 500 index additions Index funds Tracking error Price pressure Strategic trading;

    References

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    1. Jeffrey Wurgler & Ekaterina Zhuravskaya, 2000. "Does Arbitrage Flatten Demand Curves for Stocks?," Yale School of Management Working Papers ysm152, Yale School of Management, revised 01 Nov 2001.
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    4. Ron Kaniel & Gideon Saar & Sheridan Titman, 2008. "Individual Investor Trading and Stock Returns," Journal of Finance, American Finance Association, vol. 63(1), pages 273-310, 02.
    5. Shleifer, Andrei, 1986. " Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-90, July.
    6. Michael Goldstein & Paul Irvine & Eugene Kandel & Zvi Wiener, 2004. "Brokerage Commissions and Institutional Trading Patterns," Discussion Paper Series dp356, The Center for the Study of Rationality, Hebrew University, Jerusalem.
    7. Edwin J. Elton & Martin J. Gruber & Jeffrey A. Busse, 2004. "Are Investors Rational? Choices among Index Funds," Journal of Finance, American Finance Association, vol. 59(1), pages 261-288, 02.
    8. Greenwood, Robin, 2005. "Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage," Journal of Financial Economics, Elsevier, vol. 75(3), pages 607-649, March.
    9. William B. Elliott & Richard S. Warr, 2003. "Price Pressure on the NYSE and Nasdaq: Evidence from S&P 500 Index Changes," Financial Management, Financial Management Association, vol. 32(3), Fall.
    10. Chemmanur, Thomas J. & He, Shan & Hu, Gang, 2009. "The role of institutional investors in seasoned equity offerings," Journal of Financial Economics, Elsevier, vol. 94(3), pages 384-411, December.
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    Cited by:
    1. Gonul Colak, 2012. "IPO characteristics of index firms," Managerial Finance, Emerald Group Publishing, vol. 38(12), pages 1134-1159.

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