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FTSE/JSE Index Migration: Testing for the Index Effect in Stocks Entering and Exiting the Top 40

Author

Listed:
  • Nico Katzke

    (Department of Economics, Stellenbosch University and Prescient Securities)

  • Charlotte van Tiddens

    (Department of Economics, Stellenbosch University and Prescient Securities)

Abstract

This paper seeks to uncover whether periodic changes to the constituents in the Top 40 index lead to price distortions during quarterly index rebalancing. The premise for this research follows from the notable increase in assets under management of index tracker funds both globally and locally, in recent years. A larger asset base tracking a given index would imply larger volumes of forced buying and selling by passive tracker funds when changes are made to the constituents underlying the index. This follows as the passive trackers are tracking error sensitive as opposed to being price sensitive, which should lead to predictable excesses in demand for stocks entering and supply of stocks exiting the index. The objective of this research is to uncover whether these dynamics result in price distortions in the local index, and in particular whether it can be profitably exploited by front-running anticipated changes. Our study indeed confirms the existence of a highly profitable index effect, conditional upon timing trading actions correctly and being able to accurately predict entrants and deletions ahead of the public announcement.

Suggested Citation

  • Nico Katzke & Charlotte van Tiddens, 2019. "FTSE/JSE Index Migration: Testing for the Index Effect in Stocks Entering and Exiting the Top 40," Working Papers 10/2019, Stellenbosch University, Department of Economics.
    • Handle: RePEc:sza:wpaper:wpapers324
    as

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    File URL: https://www.ekon.sun.ac.za/wpapers/2019/wp102019/wp102019.pdf
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    References listed on IDEAS

    as
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    4. Green, T. Clifton & Jame, Russell, 2011. "Strategic trading by index funds and liquidity provision around S&P 500 index additions," Journal of Financial Markets, Elsevier, vol. 14(4), pages 605-624, November.
    5. Hsiu-Lang Chen, 2006. "On Russell index reconstitution," Review of Quantitative Finance and Accounting, Springer, vol. 26(4), pages 409-430, June.
    6. Kappou, Konstantina & Brooks, Chris & Ward, Charles, 2010. "The S&P500 index effect reconsidered: Evidence from overnight and intraday stock price performance and volume," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 116-126, January.
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    More about this item

    Keywords

    Index front-running; passive rebalancing trade;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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