The market impact on shares entering or leaving JSE indices

Abstract

This study attempts to measure the effects on the share price of companies entering and exiting four FTSE/JSE indices; the J200, J210, J213 and J260. While results showed only weak statistical significance, systematic patterns were observed during the event window. Share prices of companies entering and exiting value weighted indices responded consistently with the investor awareness hypothesis. Share prices of companies entering and exiting indices weighted by fundamental factors responded consistently with the information hypothesis. The cumulative average abnormal returns (CAARs) were permanent and did not reverse within the first 200 days after the index change for all indices. Abnormal returns were calculated by using the market model and a one factor CAPM model. The market model was a superior benchmark in this study. This study found that the CAARs for index changes became positive only after the date of the index change. This implies that either the effect of passive index funds on the JSE is not significant, or that passive funds are allowed to incur tracking errors in order to trade strategically to secure the best price for a reconstituted portfolio. This conclusion is supported by the fact that there was no observable change in the index premium over time. The findings of this study may indicate market inefficiency, which means that arbitrage opportunities may exist around index changes.