EFFECT OF INDEX REBALANCING ON STOCK RISK RETURN DYNAMICS OWNERSHIP PATTERNS AND CORPORATE POLICY A STUDY OF INDIAN MARKETS

Abstract

Stock market Indices are considered as a benchmark for market performance. Therefore, it s imperative to conduct index rebalancing regularly by adding new stocks that are more representative of the market picture and delete stocks which fall below threshold liquidity, delisted, acquired or any other rules determined by index companies. The rules defined by index companies are not associated with fundamental news; hence it creates a compelling case for companies to be part of the index that improves stock valuations and increased access to capital markets.and#61607; Consistent with the literature, this thesis supports price pressure effect on stocks across addition and deletion categories. There is a sign of reversal for stock additions and deletions in the duration of 90 days after the index rebalancing event. However, in long-term, the deletions category of losers shows the negative impact on stock valuations. This finding supports symmetrical returns for addition and deletion categories i.e. equal and opposite in size of rebalancing effect. The finding is contrary to Chen et al. (2004) where they argued complete reversal for deletions resulting in asymmetry of returns. Using the market structure, I propose to compute transition cost of stock movement from subordinate index to prominent index i.e. Nifty Next 50 to Nifty 50. This cost is approximately 28% on average for the period of study. and#61607; The result reveals that there is higher volatility persistence observed among additions category of stocks. Where upgrade is experiences volatility half life of 21.8 days followed by Emergent and Heavy weights with 8.9 and 6.6 days of re-balancing effect. The deletions category Losers stocks display 6.2 days and Demotes 1.15 days. Hence, there is a quantification of index rebalancing effect in number of days. Whereas in case of leverage effect (influence of bad news on returns) the deletions category are impacted most after rebalancing.