S&P 500 Index Changes and Investor Awareness

Journal of Investment Management, Forthcoming

Posted: 22 Jan 2005

See all articles by Honghui Chen

Honghui Chen

Department of Finance, University of Central Florida

Vijay Singal

Virginia Tech

Gregory Noronha

University of Washington, Tacoma - Milgard School of Business

Abstract

We find that, on average, firms added to the S&P 500 index experience a permanent price increase, while those deleted from it suffer only a temporary price decline. Existing theories, such as a downward sloping demand curve, liquidity, and information, fail to explain the asymmetric response. We propose a new explanation for the observed price patterns: changes in investor awareness. Investors become more aware of a stock upon its addition to the S&P 500 index but do not become similarly unaware of a stock following its deletion. This results in a significant price increase after an addition but not an equivalent decline after a deletion. Consistent with our hypothesis, we find that Merton's (1987) measure of awareness improves after an addition but remains essentially unchanged after a deletion. The price reaction is related to changes in the measure of awareness.

From a practical standpoint, our results suggest that index fund managers who are not constrained by tracking error minimization are better off not trading on the effective date. Rather, they may be able to benefit their shareholders by executing purchases of additions upon announcement, but waiting to sell deleted firms until well after the effective date.

Keywords: Index changes, index funds, S&P 500 index, investor awareness, downward sloping demand curve

JEL Classification: G12, G23

Suggested Citation

Chen, Honghui and Singal, Vijay and Noronha, Gregory, S&P 500 Index Changes and Investor Awareness. Journal of Investment Management, Forthcoming. Available at SSRN: https://ssrn.com/abstract=651961

Honghui Chen

Department of Finance, University of Central Florida ( email )

PO Box 161400
Orlando, FL 32816
United States
407-823-0895 (Phone)

Vijay Singal (Contact Author)

Virginia Tech ( email )

Blacksburg, VA 24061
United States
5402317750 (Phone)

Gregory Noronha

University of Washington, Tacoma - Milgard School of Business ( email )

1900 Commerce Street
Campus Box 358420
Tacoma, WA 98402-3100
United States

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