On the Changes to the Index Inclusion Effect with Increasing Passive Investment Management
Finance and Financial Management
This paper provides an empirical analysis of the index inclusion effect for additions to the S&P 500 index between 1981 and 2015. The analysis finds that between 1990 and 2015 the average excess return for additions from the announcement to effective day was 5.64%. The analysis goes further by exploring the average excess returns due to inclusion in each year. The paper then seeks to determine whether the magnitude of the index inclusion effect is affected by the growth in the passive management industry by regressing a number of different measures of passive holdings against the intra-year inclusion effect averages. Based on past theories, more passively linked funds should create a larger shift in the demand curves for the stocks around inclusion, but the results do not yield such conclusions. The index inclusion effect appears to have peaked in the late 1990s while the passive management industry has continued to grow.