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A re-examination of the index effect: Gambling on additions to and deletions from the S&P 500's [`]gold seal'

  • Kappou, Konstantina
  • Brooks, Chris
  • Ward, Charles W.R.

This study examines the abnormal returns, trading activity, volatility and long-term performance of stocks that were added to the S&P 500 index. By using a three-factor pricing model that allows for firm size and value characteristics as well as market risk, we are able to shed new light on the widely observed [`]index effect'. We find that the CAPM tends to overstate the performance of large firms and to understate the performance of small firms. We also find a transitory increase in trading volume between the announcement and a few days after the effective date. In terms of the firm's operating performance, we find a significant increase in earnings per share after inclusion, which combines with the stock price rise to leave the average price-earnings ratio largely unaltered. Examining a unique sample of deletions of international companies and replacements with US companies, we find that deleted stocks experienced a considerable and permanent fall in price, inconsistent with the Investor Recognition Hypothesis. The "seal" of S&P 500 index membership has very long-term effects and inclusion appears not to be an information-free event.

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Article provided by Elsevier in its journal Research in International Business and Finance.

Volume (Year): 22 (2008)
Issue (Month): 3 (September)
Pages: 325-350

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Handle: RePEc:eee:riibaf:v:22:y:2008:i:3:p:325-350
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