The Russell Reconstitution Effect
Investment Technology Group Working Paper No. 01-01
25 Pages Posted: 29 Jul 2001
Date Written: September 2001
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: Suggested Citation