Price Response to Factor Index Additions and Deletions

Abnormal price reaction around S&P 500 index changes has been considered as strong evidence that long term demand for stocks is downward sloping. This notion, however, has recently lost popularity due to the evidence that new additions are accompanied with a contemporaneous change in future earnings expectations. In this study we show that factor index rebalancing is a true information free event. The cumulative abnormal return from announcement to effective day is 1.07% for new additions and -0.91% for new deletions and around two-thirds of this effect is permanent. We find a direct relationship between the magnitude of abnormal returns and the abnormal volume coming from index funds. The documented effect results in a direct loss to index fund investors of 16.5 bps per annum.

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