FEATURE: TRADING
September 2003 to August 2008. Despite the decline, S&P 500
excess returns from AD to ED remain the highest among the group.
STATS.
Th e FTSE 100 is the only index where index eff ects have
exhibited an increase, from 0.03% to 1.79%. However, the AD to
FIGURE 1: MEDIAN EXCESS RETURNS OF ADDITIONS S&P
ED returns are still lower than in the US and Japan, which is to be
expected given the predictability of the changes. 09/1998 to 08/2003 09/2003 to 08/2008
8
7
WHY IS THERE A DECLINE?
Th e index eff ect may have fallen victim to its own popularity.
6
Over the past decade, hedge funds and proprietary trading desks
5
have increased their market participation in index trades to exploit
4
%
this opportunity, which has diminished profi ts.
3
Second, changes in market structure and trading patterns of
2
1
index funds have dented the index eff ect. For example, in the US,
0
decimalisation of US stock trades in 2001 and the institution of a
-1
closing cross at the Nasdaq in 2003 have had a meaningful impact
-2
on the post-addition price pop for S&P 500 changes. Similarly, AD+1 ED ED+1 ED+2 ED+3 ED+4 ED+5
the greater integration of trading venues and growth of non-
exchange markets for block trades in Europe may have impacted
the observed index eff ect for FTSE 100 and DAX 30.
Anecdotal evidence suggests that index funds have also begun
FIGURE 2: MEDIAN EXCESS RETURNS OF ADDITIONS NIKKEI
to trade diff erently over the past decade. Instead of simply trading
at the close, many trade around the close to get the price, and they
09/1998 to 08/2003 09/2003 to 08/2008
15
may on occasion transfer the risk to trading desks that guarantee
them the closing price.
12
Our study confi rms that the index eff ect is still present and
may never disappear. However, the magnitude of price changes
9
%
that have been previously associated with index additions has
6
begun to diminish in the past fi ve years.
Th e effi cient market hypothesis argues that markets follow a
3
random walk. As such, the presence of index eff ects is simply another
0
market anomaly that will be arbitraged away to a point where there
may be a small observable price pop, but it may not be executable. -3
Traders seeking to profi t from index changes are better off
AD+1 ED ED+1 ED+2 ED+3 ED+4 ED+5
seeking opportunities in lesser known areas, such as trading index
changes in the options market or trading index share changes.
FIGURE 3: MEDIAN EXCESS RETURNS OF ADDITIONS FTSE
PROFILE – FACT BOX
09/1998 to 08/2003 09/2003 to 08/2008
2.0
1.5
Aye M Soe 1.0
Career highlights: 0.5
Aye M Soe is a director of index % 0.0
research and analysis at the Global -0.5
Research and Design Group at -1.0
Standard & Poor’s. Prior to joining -1.5
Standard & Poor’s in 2007, she held -2.0
analytical positions at Morgan Stanley -2.5
and FactSet Research Systems. Soe -3.0
received a BA from Tufts University
AD+1 ED ED+1 ED+2 ED+3 ED+4 ED+5
and an MA in Economics from
Fordham University.
WWW.CFAUK.ORG PROFESSIONAL INVESTOR 31
29-3129-31 Shrinking indices.indd 31Shrinking indices.indd 31 1/6/091/6/09 11:52:2911:52:29Professional Investor Summer 09.33 33 4/6/09 15:40:58
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