NZX50: Increased Investibility and Price Pressure on Additions
and Deletions
By: Nick McVerry and Ed Vos*
Abstract:
By examining additions and deletions to the NZX50 index since its inception in 2003 we
show that the stated objective of the change in index, to ‘increase investibility’, seems to have
been achieved. We observe increased price pressure, compared to changes to the NZSE 40
index. This pressure seems sustained for additions, contrary to the expectations of an
efficient market. Sustained higher trading volume for additions supports the price pressure
hypothesis.
*Correspondence to:
Ed Vos
Department of Finance
Waikato Management School
Private Bag 3105 Hamilton
New Zealand
Email: [email protected]
NZX50: Increased Investibility and Price Pressure on Additions and Deletions
Abstract:
By examining additions and deletions to the NZX50 index since its inception in 2003 we
show that the stated objective of the change in index, to ‘increase investibility’, seems to have
been achieved. We observe increased price pressure, compared to changes to the NZSE 40
index. This pressure seems sustained for additions, contrary to the expectations of an
efficient market. Sustained higher trading volume for additions supports the price pressure
hypothesis.
2
Introduction
In theory, the value of a share should equal the risk adjusted expected present value of the
future cash flows flowing from the firm to the holder of the share. Further, in an ‘efficient’
market all available information is included in the price. Thus, it is a bit of a mystery why
the value of a share changes when it is added to or deleted from the popular share-index –
when nothing else may have happened to the expected future cash flows of the firm. Reasons
for these changes are studied recently as 2004 in the Journal of Finance paper by Chen,
Noronha, and Signal where they find permanent increases for deletions to the S&P 500 but
only temporary decreases for deletions. At least five theories for these variations have been
developed in the literature (discussed below) which attempt to reconcile efficient market
theory with what is observed in practice.
While these findings are most often associated
with foreign share indices, predominantly the S&P 500 Index, previous studies with a New
Zealand focus have confirmed the applicability of the effect to the New Zealand market and
the NZSE 40 Index specifically (Elayan, Li, and Pinfold (2001) and Hyland and Swidler
(2002)). We study this effect since changes have been made to the New Zealand index.
Following a strategic review of the New Zealand Stock Exchange indices in late 2002 the
NZX adopted a new headline index, the NZX 50, to replace the NZSE 40 Index effective
from March 2003, and later updated the other NZ indices to ensure consistency in terms of
index methodology. The changes were designed to provide indices which better reflected the
performance of the New Zealand market and “to improve their overall investibility” (NZX,
2002). The adoption of a free-float methodology, presentation of values in gross terms and
an increased size of the headline index were the main changes implemented. While the
NZSE 40 Index continued to be published until April 2004, the NZX 50 quickly became the
predominant benchmark for the New Zealand market.
This paper examines the effect the changes to the headline New Zealand index specifically
have had in terms of the “index effect”. Specifically we investigate whether the adoption of
the free-float index methodology has reduced the extent of the index effect, and in doing so
increased the efficiency of the market, or whether the assertion that the changes will lead to
“increased investibility” has been proven accurate such that increased price pressure has in
fact increased the extent of the index effect. We find significant evidence supporting the
latter explanation. The extent of abnormal price change for both additions to, and deletions
from, the NZX 50 index is significantly greater than the corresponding price changes for
3
changes to the former NZSE 40 index. This finding confirms, and in a sense justifies, the
actions of the NZX, at least in terms of their stated objectives surrounding the investibility of
the index. It must be considered however that the achievement of this goal has come at a
cost, namely a reduction in the efficiency of the market for periods surrounding index
changes.
4
New Zealand share indices
The New Zealand Stock Exchange assumed responsibility for the calculation of the NZSE 40
Index in September 1991. A market-weighted capital index, it comprised 40 of the largest
and most liquid shares traded on the New Zealand Stock Exchange. The index was the
predominant benchmark for the New Zealand market until its replacement by the NZX 50 in
2003. Entry was governed by mechanical index rules based around market capitalisation and
trading volume, such that very little discretion existed in terms of determination of changes to
the index. Revisions to the index were undertaken quarterly, with forthcoming changes
typically pre-announced by three weeks.
While the NZSE 40 was the major New Zealand
headline index of the time, and the predominant performance benchmark for the New
Zealand market, there were very few passive index funds which tracked it. The notable
exception was the “NZ Top 40 Fund” established in April 19971 which had total unitholders’
funds of approximately $10 million.
The NZX 50 Index (often referred to as the NZSX 50 Index2) is a gross index comprising the
top 50 NZX listed companies, as determined by a free-float capitalisation methodology3,
which also meet specific liquidity requirements.
The free-float approach is considered
superior to the simple market value approach used by the NZSE 40 Index as it better reflects
the proportion of a company’s shares which are readily tradable on the market by excluding
stakes held by strategic shareholders. For example a large proportion of the shares in Air
New Zealand are currently held by the New Zealand Government, such that they not freely
tradable – Air New Zealand therefore has a significantly lower weighting in the NZX 50 than
it would have in the NZSE 40. The NZX undertakes quarterly reviews of the composition of
the NZX 50 index, with additions or deletions at each review determined by reference to the
NZX 50 Index Rules (NZX, 2006). New issues qualifying for addition to the index are
typically added at the next quarterly review so long as they have traded for at least 20 days
prior. Because addition to or removal from the NZX 50 is determined by index rules rather
than subjective judgment it is often assumed that no new information exists at the
announcement of an index changes in terms of the added or deleted companies future
prospects.
1
Determined from the Trust Deed lodged with the New Zealand Companies Office.
The NZX renamed the primary market index from the NZSX 50 to NZX 50 in late 2005.
3
The free float market capitalisation excludes blocks of shares greater than 20% and blocks between 5% and
20% which are considered strategic.
2
5
In addition to the NZX 50 the value of the NZX 50 Portfolio Index is published. This
comprises the same constituent companies as the NZX 50 however limits the weighting of
each individual company to a maximum of 5%. The NZX Portfolio Index is tracked by the
NZX 50 Portfolio Index Fund (referred to as FONZ, one of a suite of NZX listed index
funds4) which listed on the NZX in December 2004. The imposed 5% cap for stocks
included in FONZ theoretically suggests the trading activities of the fund will have a greater
effect on prices of added or removed stocks relative to a fund tracking the NZX 50, as on
average stocks being added or removed represent less than 5% of the top 50 index at
inclusion/removal (such that their representation in the NZX 50 Portfolio will be greater than
in the NZX 50). The existence of the FONZ fund should therefore increase any price effect
surrounding NZX 50 changes; however its influence in practice is likely to be limited by its
relatively small market capitalisation, currently $38 million.
On the other hand we would
expect the majority of New Zealand managed equity funds to see the NZX 50 Portfolio Index
as an easily replicable investment strategy.
In principle the free-float methodology of the NZX 50 should affect the extent of any price
effect as added stocks should be sufficiently liquid to absorb any abnormal buying pressure.
This should lead to an increase in market efficiency. So if there is price pressure, it must be
strong enough to overcome increases in market efficiency.
However the increase in
popularity of index funds, motivated in part by research identifying the relative
underperformance of active managed fund (for example Gruber, 1996) has led to an increase
in the size of such funds to the extent that an increased price effect may be expected, despite
the effect of the free-float index methodology. New Zealand active managed funds use the
NZX 50 as a performance benchmark (typically documented in the investment statement5). It
is likely therefore that at least some of these funds will maintain a portfolio with a similar
composition to the NZX 50 so as to lessen the risk of significant underperformance relative to
the NZX 50.
Background
4
Others members of the SmartShares family include TENZ (comprising the top 10 NZX listed firms) and MIDZ
(comprising the bottom 40 of the NZX 50 firms).
5
Examples include the TOWER New Zealand Equity Trust, The Russell New Zealand Shares Fund and the
Milford Equities Research Fund.
6
The price effects surrounding index changes have been extensively studied since Harris and
Gurel (1986) and Shleifer (1986) first identified a significant positive price effect for stocks
added to the S&P 500 Index. At least five different hypotheses have subsequently been
developed to explain the price responses identified.
The price pressure hypothesis predicts a temporary price increase for stocks added to an
index on account of the purchasing activities of managed funds. The hypothesis, which
predicts the abnormal price increase will reverse once the initial buying pressure initiated by
the index change dissipates, was first supported by Harris and Gurel (1986) for the period
1978-1983, who identify increased trading volume in conjunction with a price increase of
more than 3 percent, and a consistent reversal of this initial price increase within 2 weeks.
Pruitt and Wei (1989) confirm the conjecture presented by Harris and Gurel (1986), and
Shleifer (1986) that institutional buying and selling pressures specifically are a cause of the
abnormal returns surrounding index changes, identifying an increase in institutional
ownership of added stocks following inclusion. The price pressure hypothesis appears as the
most likely explanation for the index effect in New Zealand. Elayan, Li, and Pinfold (2001)
studied additions and deletions to the NZSE 40 index from January 1991 to February 2000.
They find a cumulative abnormal return of +2.13 percent over the interval from one trading
day before the effective date to the effective date for added stocks, and a cumulative
abnormal return of -2.51 percent for deletions. These results they conclude most strongly
support the price pressure hypothesis. The free-float methodology adopted by the NZX 50
Index should in theory mitigate price pressure, ensuring only sufficiently liquid stocks are
added to the index.
The imperfect substitute hypothesis, also referred to as the downward sloping demand curve
hypothesis, predicts a positive increase in price for stocks added to an index because of a
reduction in the number of freely traded shares. This effect is consistent with a downward
sloping demand curve for stocks.
The early work of Shleifer (1986) supports the DS
(downward sloping) hypothesis, as does the more recent evidence of Lynch and Mendenhall
(1997) who identify no permanent increase in value of shares traded following index changes.
More recent studies including Denis, McConnell, Ovtchinnikov, and Yu (2003) however
have raised doubt as to the applicability of the DS hypothesis by testing one of its key
assumptions - that index addition is an information free event. By comparing analysts’
earnings per share (eps) forecasts for S&P 500 added stocks relative to benchmark stocks
7
they ascertain that index inclusion is an information event, a finding which significantly
undermines the DS hypothesis, at least in terms of its applicability to the S&P500. This
hypothesis has a degree of merit in a New Zealand context because of the small nature of our
share market, with less than 150 listed companies the existence of even a ‘close substitute’ is
rare.
The liquidity hypothesis suggests that index inclusion will lead to closer scrutiny of a
company by analysts and investors such that there will be an increase in public information
on the company and a subsequent reduction in bid-ask spreads, thereby improving liquidity.
Improved liquidity lowers the required rate of return, thereby providing an immediate price
increase upon index inclusion. Studies supporting the liquidity hypothesis include Edminster,
Graham and Pirie (1996) who find a permanent increase in trading volume (a proxy for
liquidity) following index inclusion, Beneish and Whaley (1996) who identify a long term
increase in trading volume and reduction in bid/ask spread following S&P 500 inclusion, and
Erwin and Miller (1998) who identify reduced bid/ask spreads and a permanent price increase
for nonoptioned stocks added to the S&P 500. This hypothesis seems unlikely in a New
Zealand context as the small size of our market means the addition to an index is unlikely to
result in any significant increase in analyst following, and similarly the removal from an
index is unlikely to cause analysts to cease following the company.
The information hypothesis suggests index inclusion has an effect on the level of information
available on a stock such that it positively influences its price, the hypothesis is largely
consistent with the liquidity hypothesis however doesn’t require increased trading volume to
be identified for it to be confirmed. The announcement of index changes may also contain
information in relation to the future prospects of the firms that has an influence on prices.
One of the earliest acknowledgements of the information hypothesis in relation to S&P 500
Index inclusions is Jain (1987) which concludes the information hypothesis as the most likely
explanation for the price effects identified.
Beneish and Gardner (1995) attribute their
findings of unaffected price, volume and information on stocks added to the Dow Jones
Industrial Average (DJIA), but reduced price, volume and information on stocks deleted from
the DJIA to the information hypothesis. The recent study by Chen, Noronha, and Singal
(2004) extends this hypothesis by applying Merton’s Shadow Cost theory which measures
investor awareness, their findings of an asymmetric price response to index changes are
largely explained by associated changes investor awareness, largely consistent with the
8
information hypothesis. Denis, McConnell, Ovtchinnikov, and Yu (2003) verify S&P 500
index changes as information events and in doing so conjecture that it is the skills and
knowledge of Standard and Poor’s staff which is inherent in the index change announcements
and that causes the significant price reaction. The use of mechanical index rules means this
hypothesis lacks credibility in a New Zealand context.
The selection criteria effect hypothesis suggests it is the strong fundamentals of added stocks
that causes permanent increases in their stock prices, in particular stocks added are those for
which strong past performance has led to an increased market capitalisation such that they
qualify for entry (Edminster, Graham and Pirie, 1994). This hypothesis alone however is
unable to explain the significant abnormal returns on the effective date of inclusion. This
hypothesis may have merit in a New Zealand context if it is found that there are no complete
reversals of abnormal returns for either additions or deletions. A study by Hyland and
Swidler (2002) examines additions to the NZSE 40 index and with reference to monthly, as
opposed to daily, abnormal returns. Their sample which comprises all newly added stocks
from September 1991 to May 1999, a total of 31 additions, finds cumulative abnormal returns
of 24.06% as well as increased trading volume for the six months preceding the addition and
suggests investors are aware of the addition of a stock well in advance. While the authors
consider these results consistent with an attention or information hypothesis, they are perhaps
more related to the selection criteria effect hypothesis described here.
Hypotheses
The main hypothesis of this paper is that the changes made to the New Zealand share indices
in 2003 and specifically the establishment of the NZX 50 Index and implantation of a free
float adjustment will result in a more pronounced price effect surrounding index changes
(both additions and deletions) on account of the “increased investibility” of the NZX 50
relative to the former NZSE 40 Index, in spite of the expected increases in market efficiency
from the change to a free float methodology.
Data
The data comprises changes (additions and deletions) to the NZSE 40 and NZX 50 indices
for the period from July 1993 through to April 2006. The initial sample included all index
9
changes except those arising from the initial composition of the NZX 50 Index at its
inception. For each index change the company name, stock exchange code, nature of the
change and effective date of the change is obtained from one of three sources:
1. The appendix of Elayan, Li and Pinfold (2000) for index changes between July 1993
and October 1999.
2. Individual company stock exchange announcements for index changes between
October 1999 and September 2003 obtained from the Investment Research Group.
3. NZX press releases for index changes from March 2004 onwards.
Daily closing prices and volume data was obtained for each index change from DataStream
for 140 days before and 60 days after the effective date of the index change.
Data screening
The initial sample was screened to remove additions or deletions with insufficient daily price
data, in doing so excluding 3 additions arising from initial public offerings and 7 deletions
from takeovers or delistings.
Unavailability of DataStream data further eliminated 2
additions and 5 deletions. The sample was also screened for trading volume; stocks with an
average number of days between trades of greater than 2 days were removed, resulting in the
further loss of 3 additions and 1 deletion. Table 1 summarises the effects of the sample
screening and details the final sample.
Table 1
Summary of Index Changes
Additions
NZSE 40 NZX 50
Initial Sample
Reason for exclusion
Data unavailable
Initial public offerings
Delistings
Insufficient trading
Final Sample
Average days between trades
Total
Deletions
NZSE 40 NZX 50
Total
30
14
44
23
13
36
-1
-1
-1
-2
-2
-3
-4
-1
-5
-1
10
-3
36
-2
-1
16
-5
-2
26
7
-7
-1
23
1.03
1.00
1.02
1.03
1.00
1.02
Methodology
This study adopts an event study methodology where the effective date of index inclusion or
deletion is considered the event date (date 0). Event windows are used with capture the
10
effects of the pre-announcement of index changes (the pre-announcement period varies
throughout the sample). The market adjustment is against the NZSEALL index6.
The adjusted market model is used to calculate the expected return for each stock added to or
deleted from the index, consistent with the methodology employed by Tapping, Vos,
D’Mello and Cheung (1998) in relation to the New Zealand Stock Exchange. The formula
used to calculate expected returns is:
rit = αi + βirmt + eit
(1)
where
rit
rmt
αi
βi
eit
=
=
=
=
=
expected return of the stock
realised return for the NZSEALL Index in time period t
0
1
residual for time period t
The average returns calculated are not adjusted for thin-trading as the sample is pre-screened
for sufficient trading volume around the event date. The final sample comprises stocks with
sufficient trading frequency7 so as to mitigate the need for any thin-trading adjustment, such
as the trade-to-trade adjustment method outlined by Maynes and Rumsey (1993).
Abnormal returns (AR) were measured as the difference between actual returns and expected
returns for each stock for each trading day within the event window. The formula used is:
ARit = rit − (αi + βirmt )
where
(2)
αi + βirmt = a normal return
The average abnormal return (AAR) for each stock is calculated for each day in the event
window by the formula:
6
The NZSEALL Index comprises all domestic companies listed on the NZSX and overseas companies and dual listed
companies sufficiently large and liquid to meet the inclusion requirements of the NZX 50 Index.
7
The average days between trades for the final sample is 1.02 days.
11
AARt =
1
∑ ARit
n
(3)8
As the expected abnormal returns for any period of time should be zero, cumulative abnormal
returns (CAAR) are calculated by summing the average abnormal returns across all stocks in
each sample within the relevant time period. The formula used is:
CAAR = ∑ AARt
(4)
Volume
To measure changes in trading volume around the event date a modified version of the
conventional relative trading volume formula is employed. The formula used is:
MVR t =
1
∑ VRit
n
(5)
where
VRit =
Vit
Vmi
(6)
Where Vit is the trading volume of security i in event-time period t and Vmi is the average
trading volume of the security over the period –140 to +60. The volume ratio, VRit, is
adapted from Harris and Guruel (1986) and has an expected value of approximately 1 if there
is no change in volume surrounding the event-period relative to the whole estimation period.
In addition to the more traditional relative volume measure, this paper examines the index
effect by calculating and presenting On Balance Volume. On Balance Volume (OBV)
measures the extent of accumulation or distribution of a stock by relating volume with price.
The OBV value increases by the amount of volume traded on days where the stock price
rises, and decreases by the amount of volume traded on days where the price falls. The
formula used calculates cumulative OBV over the interval from 29 days prior to 20 days
following effective date, and normalizes the result so as to a allow maximum (minimum)
value of 100 (-100).
8
All summations include all days in the relevant time period.
12
OBVit = 100 x
∑ VOL up − ∑ VOL down
(7)
∑ VOL total
Average OBV is reported for additions and deletions sub-samples for the interval from 20
days before to 20 days after effective date and is calculated as:
OBVt =
1
∑ OBVit
n
(8)
Results
Fig. 1: Cumulative Average Abnormal Returns
A comparison of cumulative average abnormal returns f rom -20 to +20
4%
3%
2%
CAAR
1%
0%
-1%
-2%
-3%
A dditions
-4%
Deletions
-5%
-20
-15
-10
-5
0
5
10
15
20
t
Cumulative average abnormal returns
We start by analysing the additions and deletions samples as a whole, in doing so confirming
the existence of the index effect in the New Zealand market. Figure 1 clearly identifies a
positive (negative) price response for additions (deletions) from 20 days prior to 20 days after
the effective date of the index change. The average pre-announcement period9 for the entire
plotted sample is 13 days, this is generally consistent with the point at which the price effects
9
Calculated from 23 additions and 21 deletions for which the announcement date and effective date was obtained.
13
begin to become evident with the CAAR values prior to this point being insignificant from
zero. For additions the effective date CAAR is +2.92 percent (significant at the 5% level)
and is very close to the highest CAAR figure over the entire period of +3.00 percent (also
significant at the 5% level) for the period from 20 days before to 2 days following the
effective date. The price gains experienced persist for around 10 days following the effective
date, after which they begin to reverse. Cumulative average abnormal returns (CAAR) for
the period from event date to 20 days following are -1.68 percent (significant at 5 percent
significance), suggesting just over half of the price gains of the 20 days prior to index
inclusion are lost in the 20 days following the addition.
The results from the deletions sample initially appear symmetric with the additions sample,
although the extent of the price effect is larger, and the majority of the negative price effect
occurs over a shorter interval. For deletions the effective date CAAR is -3.55 percent
(significant at the 5% level), but the price effect continues beyond effective date. CAAR at 6
days following effective date is -4.63 percent, the most negative value recorded (significant at
5%). Similarly the CAAR for the 3 days period centered on the effective date is -2.82
percent (significant at 1%), larger than the CAAR for the day prior to and including the
effective date of -2.04 percent (significant at 5%). As with the initial effect, the price reversal
for deletions occurs quickly beginning around 17 days after effective date.
These results clearly identify a significant price effect for both additions and deletions to the
headline New Zealand share indices, in doing so confirming the existence of the index effect
in the New Zealand market. To better understand the reasons for the identified price effects it
is necessary to analyse changes in trading volume which is considered next.
14
Fig. 2: Relative Daily Trading Volume
A comparison of relative daily trading volume f rom -20 to +20
3.0
A dditions
2.5
Deletions
Relative Volume
2.0
1.5
1.0
0.5
0.0
-20
-15
-10
-5
0
t
5
10
15
20
Relative trading volume
Figure 2 plots the daily trading volume for both additions and deletions over the time period
from 20 days prior to 20 days following the effective date, where a value of approximately 1
represents ‘normal’ trading volume.
Increased trading volume for both additions and
deletions is evident in the few days prior to and including effective date, and is represented
by spikes in the graph.
The few days following index changes do not display any
significantly positive trading volume. To better interpret the patterns of trading around the
effective date it is necessary therefore to examine the cumulative relative trading volumes.
Table 2
Cumulative Average Relative Trading Volume
Index Additions
Index Deletions
-5 to 0
-5 to +5
-1 to 0
-1 to +1
MVR
1.4494
1.4494
1.6821
1.3621
t
2.1295
1.9388
2.2945
1.9336
sig
**
*
**
*
MVR
1.3504
1.1171
1.8676
1.4862
sig
t
1.2138
0.7688
1.8676
1.4862
*, **, and *** denote 10%, 5%, and 1% significance respectively.
Table 2 reports positive and statistically significant relative tradition volumes across four
different time periods surrounding the effective date. For example the two day period
incorporating the effective date and the day prior has an average relative trading volume of
15
1.68, equivalent to volume approximately 68% higher than ‘normal’ and significant at the 5%
level. Similarly the longer period from 5 days prior up to and including has an average
relative trading volume of 1.45 (also significant at the 5% level).
The results for the deletions sample are similarly all above one, indicating increased trading
volume relative to normal however these lack statistical significance at any conventional
significance level such that no strong conclusions are able to be drawn from these results.
Fig. 3: On Balance Volume
A comparison of cumulative average abnormal returns f rom -20 to +20
20
15
10
OBV
5
0
-5
-10
A dditions
-15
Deletions
-20
-20
-15
-10
-5
0
5
10
15
20
t
On Balance Volume
Figure 3 shows cumulative and normalized On Balance Volume (OBV) for additions and
deletions. The results are symmetric for the period up to the effective date. For additions
OBV rises, suggesting accumulation of the underlying stocks (by index funds, managed funds
and other ‘smart investors’). For deletions the falling OBV indicates distribution of the
underlying stocks, again in theory by ‘smart investors’. Following effective date however
OBV becomes asymmetric, reverting to zero for deletions, but remaining relatively constant
for the additions sample. This is important for it suggests that the partial price reversal
identified in the additions CAAR graph is not caused by selling pressure post-effective date.
16
For deletions the rising OBV suggests accumulation of the underlying stocks post effectivedate by ‘smart money’, possibly by active managed funds for which the price decrease
presents an attractive buying opportunity. It should be noted that the inclusion of OBV is
supplementary to the more accepted method of volume change measurement, presented in
figure 2. If nothing else OBV very effectively confirms the existence of an index effect in the
New Zealand market.
17
Table 3
Cumulative Average Abnormal Returns (CAAR) for Additions
NZSE 40 Additions
NZX 50 Additions
CAR
t
sig
Pos:Neg
CAR
t
sig
Pos:Neg
-20 to -10
-0.0012
-0.1166
14:12
0.0326
1.9007 *
6:4
-20 to -9
-0.0005
-0.0522
15:11
0.0427
2.4870 **
8:2
-20 to -8
0.0000
0.0005
14:12
0.0388
2.1670 *
7:3
-20 to -7
0.0020
0.1567
15:11
0.0304
1.6246
7:3
-20 to -6
0.0034
0.2493
15:11
0.0367
1.8394 *
7:3
-20 to -5
0.0076
0.5160
16:10
0.0453
2.2605 *
8:2
-20 to -4
0.0109
0.8581
19:7
0.0386
1.9203 *
8:2
-20 to -3
0.0114
0.8918
19:7
0.0413
1.9307 *
7:3
-20 to -2
0.0099
0.7562
19:7
0.0478
2.1987 *
7:3
-20 to -1
0.0146
1.1701
19:7
0.0615
3.0445 **
8:2
-20 to 0
0.0164
1.3095
17:9
0.0624
2.8417 **
8:2
-20 to 1
0.0189
1.5326
17:9
0.0568
2.4523 **
8:2
-20 to 2
0.0213
1.6936
16:10
0.0524
2.2006 *
7:3
-20 to 3
0.0201
1.6255
15:11
0.0553
2.1181 *
7:3
-20 to 4
0.0205
1.5272
16:10
0.0597
2.1940 *
7:3
-20 to 5
0.0150
1.1590
15:11
0.0615
2.2082 *
7:3
-20 to 6
0.0110
0.8032
16:10
0.0553
1.8438 *
7:3
-20 to 7
0.0088
0.6084
17:9
0.0581
1.9242 *
7:3
-20 to 8
0.0069
0.4516
15:11
0.0561
1.8729 *
7:3
-20 to 9
0.0127
0.8926
15:11
0.0577
1.7430
6:4
-20 to 10
0.0076
0.4867
15:11
0.0612
1.8056
7:3
-20 to 11
0.0102
0.6319
15:11
0.0618
1.6685
7:3
-20 to 12
0.0093
0.5732
15:11
0.0563
1.6825
7:3
-20 to 13
0.0097
0.6160
15:11
0.0584
1.7485
7:3
-20 to 14
0.0070
0.4735
14:12
0.0531
1.6751
7:3
-20 to 15
0.0097
0.6694
14:12
0.0535
1.7952
7:3
-20 to 16
0.0054
0.3514
16:10
0.0468
1.6509
7:3
-20 to 17
-0.0014
-0.0847
14:12
0.0497
1.6975
7:3
-20 to 18
-0.0078
-0.4409
12:14
0.0432
1.5768
6:4
-20 to 19
0.0002
0.0092
13:13
0.0418
1.5156
6:4
-20 to 20
-0.0056
-0.3252
13:13
0.0533
2.1048 *
7:3
0 to 1
0.0044
0.9467
17:9
-0.0047
-1.0914
4:6
0 to 2
0.0068
1.1610
13:13
-0.0091
-1.5030
2:8
0 to 3
0.0055
0.7869
12:14
-0.0062
-0.6585
3:7
0 to 4
0.0059
0.9160
13:13
-0.0018
-0.1444
5:5
0 to 5
0.0004
0.0540
13:13
0.0000
-0.0003
4:6
0 to 6
-0.0035
-0.5027
10:16
-0.0062
-0.4559
5:5
0 to 7
-0.0058
-0.8331
9:17
-0.0034
-0.2763
5:5
0 to 8
-0.0077
-0.9531
9:17
-0.0054
-0.4390
3:7
0 to 9
-0.0018
-0.2457
12:14
-0.0038
-0.2690
3:7
0 to 10
-0.0070
-0.8531
13:13
-0.0003
-0.0185
4:6
0 to 11
-0.0044
-0.5118
10:16
0.0003
0.0165
5:5
0 to 12
-0.0053
-0.6385
12:14
-0.0052
-0.3556
4:6
0 to 13
-0.0049
-0.5718
12:14
-0.0031
-0.2105
4:6
0 to 14
-0.0076
-0.8587
9:17
-0.0084
-0.6345
5:5
0 to 15
-0.0049
-0.5283
9:17
-0.0080
-0.6591
5:5
0 to 16
-0.0091
-1.0944
9:17
-0.0147
-1.1689
3:7
0 to 17
-0.0159
-1.8376 *
9:17
-0.0118
-0.9082
4:6
0 to 18
-0.0223
-2.1530 **
9:17
-0.0183
-1.5450
2:8
0 to 19
-0.0144
-1.4381
10:16
-0.0197
-1.5926
3:7
0 to 20
-0.0202
-1.9811 *
10:16
-0.0082
-0.8936
4:6
-1 to 0
0.0065
1.2024
14:12
0.0146
1.8057
7:3
-1 to 1
0.0090
1.4154
15:11
0.0089
1.4196
8:2
*, **, and *** denote 10%, 5%, and 1% significance respectively.
18
Fig. 4: Index Additions
A comparison of cumulative average abnormal returns (CA A R) f or additions
to the NZSE 40 and NZX 50 over days -20 to +20
7%
6%
Cumulative Average Abnormal Returns
5%
4%
3%
2%
1%
0%
-1%
NZX 50
NZSE 40
-2%
-20
-15
-10
-5
0
5
10
15
20
t
NZSE 40 and NZX 50 sub-sample additions
To test the main hypothesis of this paper results are presented which compare the abnormal
returns to additions between the additions to the NZSE 40 and additions to the NZX 50.
Table 3 and figure 4 present the cumulative average abnormal returns (CAAR) for additions
to the individual indices. A dramatic difference in terms of the extent of the price response is
evident from the first graph, with the CAAR at effective date for NZX 50 additions being
more than three times greater than the equivalent NZSE 40 value. The figure, +6.24 percent
is statistically significant at the 5% level.
The second obvious difference between the indices is the extent of the price reversal.
Additions to the NZSE 40 lose all of the previous gains within 18 days after the effective
date, the CAAR for the period from effective date to 18 days after is -2.23% (significant at
the 5% level). By contrast the majority of the price effects for additions to the NZX 50
persist, with the CAAR for the period from days 20 prior to 20 days following effective date
economically significant at +5.33% (significant at the 10% level).
19
Table 4
Cumulative Average Abnormal Returns for Deletions
NZSE 40 Deletions
CAR
t
sig
Pos:Neg
CAR
-20 to -10
0.0226
1.2229
10:6
-0.0180
-20 to -9
0.0069
0.4704
8:8
-0.0215
-20 to -8
0.0130
0.8819
10:6
-0.0238
-20 to -7
0.0123
0.9277
9:7
-0.0238
-20 to -6
0.0094
0.7157
9:7
-0.0296
-20 to -5
0.0062
0.4870
10:6
-0.0287
-20 to -4
0.0031
0.2231
8:8
-0.0292
-20 to -3
0.0050
0.3463
8:8
-0.0352
-20 to -2
-0.0027
-0.1700
7:9
-0.0437
-20 to -1
-0.0066
-0.3521
8:8
-0.0670
-20 to 0
-0.0251
-1.2822
8:8
-0.0594
-20 to 1
-0.0346
-1.6823
6:10
-0.0633
-20 to 2
-0.0387
-1.7606 *
5:11
-0.0560
-20 to 3
-0.0307
-1.3388
7:9
-0.0523
-20 to 4
-0.0389
-1.7988 *
6:10
-0.0515
-20 to 5
-0.0301
-1.4406
8:8
-0.0581
-20 to 6
-0.0316
-1.5314
7:9
-0.0800
-20 to 7
-0.0219
-1.1531
8:8
-0.0761
-20 to 8
-0.0239
-1.2465
8:8
-0.0753
-20 to 9
-0.0219
-1.0182
7:9
-0.0717
-20 to 10
-0.0283
-1.3378
6:10
-0.0735
-20 to 11
-0.0226
-0.9959
6:10
-0.0782
-20 to 12
-0.0297
-1.4920
7:9
-0.0736
-20 to 13
-0.0253
-1.2173
7:9
-0.0711
-20 to 14
-0.0264
-1.0761
6:10
-0.0673
-20 to 15
-0.0243
-0.9016
6:10
-0.0671
-20 to 16
-0.0246
-1.0692
6:10
-0.0588
-20 to 17
-0.0237
-1.0894
7:9
-0.0257
-20 to 18
-0.0182
-0.7724
7:9
-0.0214
-20 to 19
-0.0280
-1.0812
8:8
-0.0248
-20 to 20
-0.0141
-0.4889
7:9
-0.0165
0 to 1
-0.0280
-2.8136 **
3:13
0.0037
0 to 2
-0.0322
-2.6643 **
4:12
0.0110
0 to 3
-0.0242
-1.7184
7:9
0.0147
0 to 4
-0.0323
-2.1120 *
6:10
0.0154
0 to 5
-0.0235
-1.6618
7:9
0.0089
0 to 6
-0.0250
-1.7168
5:11
-0.0130
0 to 7
-0.0154
-1.1734
6:10
-0.0091
0 to 8
-0.0173
-1.3965
4:12
-0.0083
0 to 9
-0.0153
-1.0264
6:10
-0.0047
0 to 10
-0.0218
-1.1883
6:10
-0.0066
0 to 20
-0.0076
-0.4273
7:9
0.0505
0 to 21
-0.0134
-0.8511
5:11
0.0579
0 to 22
-0.0055
-0.3669
8:8
0.0686
0 to 23
-0.0031
-0.2220
8:8
0.0667
-1 to 0
-0.0224
-0.8343 *
3:13
-0.0157
-1 to 1
-0.0319
-1.9334 **
3:13
-0.0196
*, **, and *** denote 10%, 5%, and 1% significance respectively.
NZX 50 Deletions
t
sig
Pos:Neg
-1.4796
3:4
-1.3085
2:5
-2.0182 *
1:6
-2.3787 *
1:6
-2.6812 **
1:6
-4.1746 ***
0:7
-2.6713 **
1:6
-4.0081 ***
0:7
-3.9417 ***
0:7
-3.2542 **
0:7
-3.0680 **
1:6
-3.5806 **
0:7
-3.1041 **
0:7
-2.9115 **
0:7
-2.4102 *
1:6
-2.4072 *
0:7
-3.1334 **
1:6
-3.1286 **
1:6
-2.8131 **
1:6
-2.5558 **
1:6
-2.4731 **
1:6
-2.5097 **
1:6
-2.2634 *
2:5
-2.0621 *
2:5
-2.0988 *
2:5
-1.7280
2:5
-1.7209
3:4
-0.5318
3:4
-0.4335
3:4
-0.4934
3:4
-0.3628
3:4
0.4663
2:4
1.1278
4:2
1.1778
3:3
1.0967
3:3
0.6633
4:2
-0.6616
2:4
-0.4967
2:4
-0.4471
3:3
-0.2582
3:3
-0.3323
3:3
1.4785
4:2
1.7956 *
4:2
1.8694 *
4:2
1.7356 *
4:2
-1.4091
1:6
-1.6684
2:5
20
Fig. 5: Index Deletions
A comparison of cumulative average abnormal returns (CA A R) f or deletions
to the NZSE 40 and NZX 50 over days -20 to +20
4%
Cumulative Average Abnormal Returns
2%
0%
-2%
-4%
-6%
-8%
NZX 50
NZSE 40
-10%
-20
-15
-10
-5
0
5
10
15
20
t
7.6 NZSE 40 and NZX 50 deletions sub-sample
Table 4 and figure 5 present CAAR results for the deletions sub-samples. Similar to the
additions sample, deletions to the NZX 50 Index are associated with a significantly larger
price effect relative to the NZSE 40 Index. The CAAR at effective date for NZX 50 deletions
is -5.94 percent (significant at the 5% level) and at 6 days following effective date is even
more negative at -8.00% (also significant at the 5% level). The comparative NZSE 40
effective date CAAR is only -2.5% however value this lacks statistical significance. The
CAAR value 4 days following the effective date (which is significant at the 10% level) is still
less negative then for deletions from the NZX 50, at only -3.89%.
Again as with the additions samples, there is a different price effect post-effective date. The
NZX 50 CAAR values from effective date onwards are predominantly positive, for the period
up to 22 days following effective date NZX 50 deletions report a CAAR of +6.86 percent
(significant at the 10% level), indicative of a price reversal which begins around day 6. For
the NZSE 40 deletions sample however no such reversal is found with each of the CAAR
values from effective date up to 23 days following deletion being negative.
21
Discussion
This paper has confirmed the existence, and measured the significance, of the index effect in
terms of the New Zealand market. The evidence from the whole sample of index additions
and deletions from July 2003 to April 2006, including changes to both NZSE 40 and NZX 50
indices over this time most strongly supports the price pressure hypothesis. It would be naive
however to attribute the price effects identified exclusively to the price pressure hypothesis.
The fact that the gains for additions, and losses for deletions only partially reverse within the
20 days following effective date is suggestive of an additional explanation. As the nature of
the index rules for both NZSE 40 and NZX 50 indices largely precludes the information
hypothesis as an explanation it is most likely therefore that the liquidity hypothesis or
selection criteria effect hypothesis are the additional explanatory hypotheses.
The more important analysis of the index effect in terms of the NZSE 40 and NZX 50 indices
individually has presented some intriguing findings. Quite clearly the index effect is more
significant surrounding changes in the newer NZX 50 index, both in terms additions and
deletions. Accepting the price pressure hypothesis as the major explanation for the index
effect in New Zealand generally therefore suggests the NZX 50 is tracked by a larger number
of institutional investors, justifying one of the stated motivations for the inception of the new
index, that of “increased investibility”.
Perhaps troubling however are the inconsistencies in terms of price reversals identified by the
sub-sample analysis. The most obvious of these inconsistencies is the lack of price reversals
for additions to the NZX 50, such evidence is contrary to the predictions of the price pressure
hypothesis and is more easily reconcilable with the selection criteria effect hypothesis.
Similarly the incomplete reversals identified for deletions from both the NZSE 40 and NZX
50 do not entirely support the price pressure hypothesis, rather these are again consistent with
the influence of a selection criteria effect.
Conclusion
Abnormal price effects have been identified for additions to, and deletions from, both the
NZSE 40 and NZX 50 indices, consistent with evidence from overseas indices including the
S&P 500 Index and also with two earlier studies into the New Zealand market. Perhaps of
more importance however are the findings in relation to the newer NZX 50 index. This paper
22
has, for the first time, documented the index effect in terms of this specific index. We have
also measured the significance of this effect, including the finding of a cumulative average
abnormal return for the 20 days up to an including effective date of +6.24 percent for
additions to the index. This is a significantly greater abnormal return than for additions to the
former NZSE 40 Index. In terms of explaining the index effects identified the price pressure
hypothesis appears to be the single best explanation, however the selection criteria effect
hypothesis has significant appeal based on the findings from the individual index sub-sample
tests, specifically the lack of complete reversals.
The findings of larger price changes for both additions to, and deletions from, the NZX 50
index justifies the actions of the NZX in terms of their stated objectives surrounding the
investibility of the index. It must be considered however that achieving this goal has come at
a cost, that is, the reduction in efficiency of the market for periods surrounding index
changes. It could be argued that the promoting an efficient market should be a higher priority
goal for the NZX than the establishment of well-followed indices, in which case the evidence
clearly suggests a failure on the part of the NZX.
Limitations
It must be noted that the generally small sample sizes throughout this study preclude
particularly strong conclusions being made.
However the sample sizes employed are
consistent with those used in earlier studies and the findings discussed are those for which the
greatest levels of statistical significance exist.
Further research
This paper has identified an intriguing anomaly in terms of the differences between index
additions to the NZSE 40 index and NZX 50 index, specifically the lack of price reversal for
NZX 50 additions and incomplete price reversals for NZX 50 deletions. A future study
which is able to compile a larger sample of NZX 50 Index changes would be valuable in
determining whether this anomaly persists and is related to a fundamental difference in cause
of the index effect between the NZX 50.
23
References
Beneish, M.D., and Gardener, J. 1995. Information costs and liquidity effects from changes in
the Dow Jones Industrial Average list. Journal of Financial and Quantitative Analysis 30(1):
135-157.
Beneish, M., and Whaley, R.E. 1996. An anatomy of the S&P game: The effects of changing
the rules. The Journal of Finance 51(1): 1909-1930.
Chen, H., Noronha, G., and Singal, V. 2004. The price response to S&P 500 Index additions
and deletions: Evidence of asymmetry and a new explanation. The Journal of Finance,
59(4): 1901-1929.
Denis, D.K., and McConnell, J.J., and Ovtchinnikov, A.V., and Yu, Y. 2003. S&P 500 Index
additions and earnings expectations. The Journal of Finance 58(5): 1821-1840.
Edminster, R.O., Graham, A. S., Pirie, W.L. 1994. Excess returns of index replacement
stocks: Evidence of liquidity and substitutability. Journal of Financial Research 17(3): 333346.
Edminster, R.O., Graham, A. S. and Pirie, W.L. 1996. Trading cost expectations: Evidence
from S&P 500 Index replacement stock announcements. Journal of Economics and Finance,
20(2): 75-85.
Elayan, F., Li, W., and Pinfold, J. 2001. Price effects of changes to the composition of New
Zealand Share Indices. The New Zealand Investment Analyst 21: 25-30.
Erwin, G.R., and Miller, J.M. 1998. The liquidity effects associated with addition of a stock
to the S&P 500 index: evidence from bid/ask spreads. The Financial Review 33: 131-146.
Gruber, M. 1996. Another puzzle: The growth in actively managed mutual funds. The
Journal of Finance 51(3): 783-810.
24
Harris, L., and Gurel, E. 1986. Price and volume effects associated with changes in the S&P
500 List: New evidence for the existence of price pressures. The Journal of Finance 41(4):
815-829.
Hyland, D.C., and Swidler, S. 2002. Trading behaviour of stocks added to New Zealand’s
NZSE40 Index. Applied Economics Letters, 9: 301-304.
Jain, P.C. 1987. The effect on stock price of inclusion in or exclusion from the S&P 500.
Financial Anlaysts Journal 43(1): 58-65.
Lynch, A.W., and Mendenhall, R.R. 1997. New evidence on stock price effects associated
with changes in the S&P 500 Index. The Journal of Business 70(3): 351-383.
Maynes, E., and Rumsey, J. 1993. Conducting event studies with thinly traded stocks.
Journal of Banking & Finance 17(1): 145-157.
NZX. 2002. NZSE announces proposal for reforming and improving indices. Retrieved June
7, 2006, from: http://www.nzx.com/aboutus/news/press/2002/indicesproposal
Pruitt, S.W., and Wei, K.C.J. 1989. Institutional ownership and changes in the S&P 500. The
Journal of Finance 44(2): 509-513
Shleifer, A. 1986. Do demand curves for stocks slope down? The Journal of Finance 41(3):
579-590.
Tapping, A., Vos, E., D’Mello, J., and Cheung, J. 1998. New Zealand takeover notice
provision selection and share price reaction. Journal of Multinational Financial Management
8(1): 317-332.
25