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Additions to Market Indices and the Comovement of Stock Returns around the World

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  • Claessens, Stijn
  • Yafeh, Yishay

Abstract

We investigate company additions to stock market indices over a six-year period in 39 developed and emerging markets around the world. For most markets, we find a post-inclusion increase in beta and an increase in the explanatory power of market returns (R2), reflecting increased comovement after inclusion between the added stock and rest of the index. In addition, for most markets there is a post-inclusion increase in stock turnover. These inclusion effects increase over time, tend to be stronger when the index is dispersed (i.e., includes many stocks), and in “common law” countries. These patterns appear to be inconsistent with the view that stock returns are generated by fundamentals only and are consistent with the category/habitat view of Barberis, Shleifer and Wurgler (2005). In line with this interpretation, we present evidence that the post-inclusion increase in comovement is positively correlated with the presence of index-oriented institutional investors in the market. We also present tentative evidence suggesting that, in less developed markets, the post-inclusion increase in comovement is related to information problems.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7052.

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Date of creation: Nov 2008
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Handle: RePEc:cpr:ceprdp:7052

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Keywords: Beta; Comovement; Index inclusion;

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  1. Randall Morck & Bernard Yeung & Wayne Yu, 1999. "The Information Content of Stock Markets: Why Do Emerging Markets Have Synchronous Stock Price Movements?," Harvard Institute of Economic Research Working Papers 1879, Harvard - Institute of Economic Research.
  2. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer, . "What Works in Securities Laws?," Working Paper 19491, Harvard University OpenScholar.
  3. Jin, Li & Myers, Stewart C., 2006. "R2 around the world: New theory and new tests," Journal of Financial Economics, Elsevier, vol. 79(2), pages 257-292, February.
  4. Ferreira, Miguel A. & Matos, Pedro, 2008. "The colors of investors' money: The role of institutional investors around the world," Journal of Financial Economics, Elsevier, vol. 88(3), pages 499-533, June.
  5. Nicholas Barberis & Andrei Shleifer, 2000. "Style Investing," NBER Working Papers 8039, National Bureau of Economic Research, Inc.
  6. Aditya Kaul & Vikas Mehrotra & Randall Morck, 1999. "Demand Curves for Stocks Do Slope Down: New Evidence From An Index Weights Adjustment," Harvard Institute of Economic Research Working Papers 1884, Harvard - Institute of Economic Research.
  7. De Nicolò, Gianni & Laeven, Luc & Ueda, Kenichi, 2008. "Corporate governance quality: Trends and real effects," Journal of Financial Intermediation, Elsevier, vol. 17(2), pages 198-228, April.
  8. Jerry Coakley & Periklis Kougoulis, 2004. "Comovement and FTSE 100 Index Changes," Money Macro and Finance (MMF) Research Group Conference 2004 11, Money Macro and Finance Research Group.
  9. Reena Aggarwal & Leora Klapper & Peter D. Wysocki, 2003. "Portfolio preferences of foreign institutional investors," Policy Research Working Paper Series 3101, The World Bank.
  10. Harford, Jarrad & Kaul, Aditya, 2005. "Correlated Order Flow: Pervasiveness, Sources, and Pricing Effects," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(01), pages 29-55, March.
  11. Bank for International Settlements, 2007. "Institutional investors, global savings and asset allocation," CGFS Papers, Bank for International Settlements, number 27, January.
  12. Bhattacharya, Utpal & Galpin, Neal, 2011. "The Global Rise of the Value-Weighted Portfolio," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(03), pages 737-756, June.
  13. Shleifer, Andrei, 1986. " Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-90, July.
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