FTSE/JSE Index Migration: Testing for the Index Effect in Stocks Entering and Exiting the Top 40

Stellenbosch Working Paper Series No. WP10/2019
 
Publication date: June 2019
 
Author(s):
[protected email address] (Department of Economics, Stellenbosch University and Prescient Securities)
[protected email address] (Department of Economics, Stellenbosch University and Prescient Securities)
 
Abstract:

This paper seeks to uncover whether periodic changes to the constituents in the Top 40 index lead to price distortions during quarterly index rebalancing. The premise for this research follows from the notable increase in assets under management of index tracker funds both globally and locally, in recent years. A larger asset base tracking a given index would imply larger volumes of forced buying and selling by passive tracker funds when changes are made to the constituents underlying the index. This follows as the passive trackers are tracking error sensitive as opposed to being price sensitive, which should lead to predictable excesses in demand for stocks entering and supply of stocks exiting the index. The objective of this research is to uncover whether these dynamics result in price distortions in the local index, and in particular whether it can be profitably exploited by front-running anticipated changes. Our study indeed confirms the existence of a highly profitable index effect, conditional upon timing trading actions correctly and being able to accurately predict entrants and deletions ahead of the public announcement.

 
JEL Classification:

G11, G14

Keywords:

Index front-running, passive rebalancing trade

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BER Weekly

26 October 2020
Last week was quiet on the domestic data front. Even so, risky assets outperformed. This included the rand exchange rate, which ignored idiosyncratic weakness in peer currency the Turkish lira. The rand was also immune to a further worsening of the COVID-19 situation in Europe. Renewed concern about the Eurozone (EZ) GDP outlook was reflected in a pullback...

Read the full issue