Does Market Response to S&P Additions Reflect Adjustment for Risk?
Journal of Risk Finance
investor sentiment, VIX, risk, market volatility, market uncertainty, S&P indices
Business | Finance and Financial Management
Purpose: The objective of this study is to investigate the value investors place on S&P index additions relative to uncertainty surrounding the firm and the market. Investors look for reassuring signals or tell-tale signs around uncertainty.
Design/methodology/approach: Variation in the market response to announcements of S&P additions to the 400, 500, and 600 indices is examined against measures of risk factors. Internal risk factors include firm size relative to the index, total firm risk, liquidity, and whether the firm is a brand new index entrant. External risk factors related to market uncertainty are measured by the Chicago Board of Exchange Volatility Index (VIX).
Findings: Firms characterized by lower market capitalization relative to the index, higher total risk, lower trading volume, and that are first time entrants to any S&P index elicit a positive market reaction compared to firms with less pricing uncertainty. In times of increased market uncertainty, investors tend to place more value on signals from respected institutions such as S&P, and riskier firms benefit more from inclusion in the S&P index. Overall, this study finds that the market overreaction is explained by the degree of uncertainty surrounding firms to be added to an index, as well as by the degree of market uncertainty, measured by VIX, at the time of the announcement.
Originality/Value: The findings suggest that investors interpret the prospect of S&P index addition as an opportunity for firms to reduce uncertainty surrounding them and thus partially hedge their exposure to market uncertainty by joining an index tracked by dozens of index funds. The value of such a hedging strategy rises for riskier firms during market turbulence.
Marciniak, Marek and Smith, Deborah D., "Does Market Response to S&P Additions Reflect Adjustment for Risk?" (2018). Business Faculty Publications. 320.