How is volatility affected when stock is added to an Index?

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Conquistador07

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Increase? Decrease?

increase because more participants are involved or decrease because investors are complacent?
 
Increase due to ETF's I would imagine, especially if it is heavily covered (ie Russell, S&P)
 
from personal experience (small sample) of watching a few stocks I covered closely get taken to indexes that previously weren't ... I'd say volatility goes DOWN!
 
I would say increase beta volitility due to ETF cash inflows and increase in market capialization.
 
From what I have seen volitilty goes up a bit.

Indexes like the S&P announce any reconstiution about a month before they actually make the changes. So all the active managers buy up the positions that all the indexers are going to HAVE to buy on the reconstitution date. Because the indexers are trying to minimize tracking error with the index itself, they want to buy the positions the second they become part of the index. The active managers exploit this weakness.

So prices generally are inflated by the active managers who are frontrunning and then shortly after the indexes and ETFs buy (and inflate prices even futher), they sell and prices fall back down.

Some indexers are willing to sacrifice tracking error and avoid this trap.



Edited 1 time(s). Last edit at Tuesday, July 3, 2007 at 09:46PM by mwvt9.
 
Hi Joey (DV),

What are your thoughts on this?

I think that long term volatility should decrease, given that a greater proportion of this will now be held by more passive institutional investors (esp. ETF's, relative value funds etc).

There will probably be short term increases in trading volumes though (as the guys have mentioned).

S
 
If that is the case Mw, that is great case for indexing. You will own the stock anyway and pay razor thin fees.
 
scourge Wrote:
-------------------------------------------------------
> Hi Joey (DV),
>
> What are your thoughts on this?
>
My thoughts on this is that a bunch of hedge funds buying equities to sell to indexers a month later at premium prices so the hedge fund can make money and the index investors get whacked is one messed up piece of finance. It seems like some interesting financial engineering could straighten this out.

I think this is an empirical question otherwise which seems pretty easy to do. Someone must have done it. My bet is that increased volume cause increased vol.
 
Here are a couple of articles to take a look at if you want....

S&P 500 data source: Anthony Lynch and Richard Mendenhall, �New Evidence on Stock Price Effects Associated with Changes in the S&P 500 Index,� Journal of Business 70, no. 3 (July 1997)

It can be found at:

http://ideas.repec.org/a/ucp/jnlbus/v70y1997i3p351-83.html

351-83. MSCI EAFE Index data source: Rajesh Chakrabarti, Wei Huang, Narayanan Jayaraman, and Jinsoo Lee, �Price and Volume Effects of Changes in MSCI Indices: Nature and Causes,� Journal of Banking and Finance 29, no. 5 (May 2005): 1237-64.

It can be found at:

http://ideas.repec.org/a/eee/jbfina/v29y2005i5p1237-1264.html

Hope this helps.
 
Thanks JDV!

I thought trading volumes should decrease when a stock is added to an index, rather than increase...definitely food for thought...

S
 
i would guess decrease volatility with increased volume.

increased volume typically means more liquid options. with more liquid options delta hedgers are smoothing out vol spikes.
 
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