Keywords: Capital markets, market efficiency, asset pricing
Abstract: This paper analyzes the effect on a company's stock price when it is added to the S&P 500
Index. A simple theoretical model is developed to show how trading effects and changes to
fundamentals should affect the price of S&P500 additions upon announcement and in the long run.
This model predicts that a company added to the S&P500 should experience an initial price increase
followed by a reversal of this price increase owing to the predicted increased stock price
volatility of companies post-addition. All of these effects should be growing over time because
of the increasing importance of S&P500 indexed mutual funds. We test the predictions of the
model using a sample of 303 S&P500 Index additions between 1978 and 1998. We find results generally
consistent with the model, particularly in the most recent period when it appears that the
post-addition increase in stock price volatility reverses almost all
of the initial price increase.
Full paper (797 KB PDF)
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Last update: October 10, 2002