On Russell index reconstitution

On Russell index reconstitution This paper investigates whether abnormal returns permanently exist in transparent U.S. Russell index reconstitution and provides evidence to disentangle the competing hypotheses associated with the index effect in the literature. Additions to Russell 1000 generate cumulative excess returns of 10.9% from 2 days before May 31 to June 30 while stocks deleted from Russell 2000 Growth Index suffer cumulative loss of 6.6%. The effect of index reconstitution on stocks in the style switching groups is moderate while it is much smaller for stocks in the retention groups. Based on daily trading volume, there is evidence that money managers tied to Russell style indexes tend not to rebalance their portfolios actively until the time of index reconstitution to avoid tracking error. However, for stocks generating large excess returns, money managers trade them actively prior to the reconstitution. This study is supportive of the imperfect substitutes hypothesis in explaining the index effect, given the absence of complete reversal of the event period abnormal returns and of consistent improvement in liquidity for the index additions. In the joint test, the price pressure hypothesis and the liquidity hypothesis explain the marginal index effect at most by 0.12% and 3.05%, respectively, while the imperfect substitutes hypothesis explains it at least by 9.21%. Furthermore, the index effect is not purely driven by individual stock price momentum. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

On Russell index reconstitution

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Publisher
Kluwer Academic Publishers
Copyright
Copyright © 2006 by Springer Science + Business Media, LLC
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-006-7441-3
Publisher site
See Article on Publisher Site

Abstract

This paper investigates whether abnormal returns permanently exist in transparent U.S. Russell index reconstitution and provides evidence to disentangle the competing hypotheses associated with the index effect in the literature. Additions to Russell 1000 generate cumulative excess returns of 10.9% from 2 days before May 31 to June 30 while stocks deleted from Russell 2000 Growth Index suffer cumulative loss of 6.6%. The effect of index reconstitution on stocks in the style switching groups is moderate while it is much smaller for stocks in the retention groups. Based on daily trading volume, there is evidence that money managers tied to Russell style indexes tend not to rebalance their portfolios actively until the time of index reconstitution to avoid tracking error. However, for stocks generating large excess returns, money managers trade them actively prior to the reconstitution. This study is supportive of the imperfect substitutes hypothesis in explaining the index effect, given the absence of complete reversal of the event period abnormal returns and of consistent improvement in liquidity for the index additions. In the joint test, the price pressure hypothesis and the liquidity hypothesis explain the marginal index effect at most by 0.12% and 3.05%, respectively, while the imperfect substitutes hypothesis explains it at least by 9.21%. Furthermore, the index effect is not purely driven by individual stock price momentum.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Jan 1, 2006

References

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