Changes in trading volume and return volatility associated with S&P 500 index additions and deletions

Abstract

When a stock is added into the S&P 500 Index, it in effect becomes cross-listed in the Index derivative markets. When index-based trading strategies such as index arbitrage are executed, the component stocks are directly affected by such trading. We find increased volatility of daily returns, plus increased trading volume for the underlying stocks. Utilizing a list of S&P 500 Index composition changes over the period September 1976 to December 2005, we study the market-adjusted volume turnover and return variance of the stocks added to and deleted from the Index. The results indicate that after the introduction of the S&P 500 Index futures and options contracts, stocks added to the S&P 500 experience statistically significant increase in both trading volume and return volatility. Both daily and monthly return variances increase following index inclusion. When stocks are removed from the index, though, neither volatility of returns nor trading volume experiences any significant change. So, we have new evidence showing that Index inclusion changes a firm's return volatility, and supporting the destabilization hypothesis.

Citation

Lin, E.C. (2010), "Changes in trading volume and return volatility associated with S&P 500 index additions and deletions", Kensinger, J.W. (Ed.) Research in Finance (Research in Finance, Vol. 26), Emerald Group Publishing Limited, Leeds, pp. 127-154. https://doi.org/10.1108/S0196-3821(2010)0000026009