DP7052 Additions to Market Indices and the Comovement of Stock Returns around the World

Author(s): Stijn Claessens, Yishay Yafeh
Publication Date: November 2008
Keyword(s): Beta, Comovement, Index inclusion
JEL(s): G10, G15
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7052

We investigate company additions to stock market indices over a six-year period in 39 developed and emerging markets around the world. For most markets, we find a post-inclusion increase in beta and an increase in the explanatory power of market returns (R2), reflecting increased comovement after inclusion between the added stock and rest of the index. In addition, for most markets there is a post-inclusion increase in stock turnover. These inclusion effects increase over time, tend to be stronger when the index is dispersed (i.e., includes many stocks), and in ?common law? countries. These patterns appear to be inconsistent with the view that stock returns are generated by fundamentals only and are consistent with the category/habitat view of Barberis, Shleifer and Wurgler (2005). In line with this interpretation, we present evidence that the post-inclusion increase in comovement is positively correlated with the presence of index-oriented institutional investors in the market. We also present tentative evidence suggesting that, in less developed markets, the post-inclusion increase in comovement is related to information problems.