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The S&P 500 effect: not such good news in the long run

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  • Daniel Cooper
  • Geoffrey Woglom
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    Abstract

    This paper analyzes the effect on a company's stock price when it is added to the S&P 500 Index. A simple theoretical model is developed to show how trading effects and changes to fundamentals should affect the price of S&P500 additions upon announcement and in the long run. This model predicts that a company added to the S&P500 should experience an initial price increase followed by a reversal of this price increase owing to the predicted increased stock price volatility of companies post-addition. All of these effects should be growing over time because of the increasing importance of S&P500 indexed mutual funds. We test the predictions of the model using a sample of 303 S&P500 Index additions between 1978 and 1998. We find results generally consistent with the model, particularly in the most recent period when it appears that the post-addition increase in stock price volatility reverses almost all of the initial price increase.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2002-48.

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    Date of creation: 2002
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    Handle: RePEc:fip:fedgfe:2002-48

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    Keywords: Stock - Prices ; Econometric models;

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    1. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
    2. Dhillon, Upinder & Johnson, Herb, 1991. "Changes in the Standard and Poor's 500 List," The Journal of Business, University of Chicago Press, vol. 64(1), pages 75-85, January.
    3. Lynch, Anthony W & Mendenhall, Richard R, 1997. "New Evidence on Stock Price Effects Associated with Changes in the S&P 500 Index," The Journal of Business, University of Chicago Press, vol. 70(3), pages 351-83, July.
    4. Kraus, Alan & Stoll, Hans R, 1972. "Price Impacts of Block Trading on the New York Stock Exchange," Journal of Finance, American Finance Association, vol. 27(3), pages 569-88, June.
    5. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
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