The Russell Reconstitution Effect

Investment Technology Group Working Paper No. 01-01

25 Pages Posted: 29 Jul 2001

Multiple version iconThere are 2 versions of this paper

Date Written: September 2001

Abstract

The equity indexes of the Frank Russell Company are widely used as performance benchmarks for investment managers. Once a year, at the end of June, the Frank Russell Company reconstitutes its stock market indexes. We document economically and statistically significant abnormal returns associated with the annual reconstitution from 1996-2001. The cross-sectional variation in abnormal returns is explained by both permanent changes in liquidity associated with changes in index membership and temporary effects related to price pressure. Our results suggest that passive index funds pay a steep price for minimizing tracking error by rebalancing on the date of reconstitution. Conversely, there are substantial rewards to supplying immediacy to such funds. However, trading on index revisions involves risks arising from sectoral movements and from timing risks as positions are unwound. Indeed, we document dramatic return volatility on the actual day of reconstitution that reflect unanticipated order imbalances.

Keywords: Russell Index, reconstitution, abnormal returns, price pressure effect, liquidity effect

JEL Classification: G10, G14

Suggested Citation

Madhavan, Ananth, The Russell Reconstitution Effect (September 2001). Investment Technology Group Working Paper No. 01-01. Available at SSRN: https://ssrn.com/abstract=278000 or http://dx.doi.org/10.2139/ssrn.278000

Ananth Madhavan (Contact Author)

BlackRock, Inc. ( email )

400 Howard Street
San Francisco, CA 94105
United States

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