PRICE AND VOLUME EFFECTS ASSOCIATED WITH THE CREATION OF STANDARD & POOR'S MIDCAP INDEX

• Author: M. Cary Collins,James W. Wansley,Breck Robinson
• Date: 01 September 1995
• Published date: 01 September 1995
• DOI: http://doi.org/10.1111/j.1475-6803.1995.tb00570.x

The Journal of Financial Research' Vol. XVIII,

NO.3'

Pages 329-350 • Fall 1995

PRICE AND VOLUME EFFECTS ASSOCIATED WITH

THE CREATION OF STANDARD &POOR'S MIDCAP INDEX

M. Cary Collins and James W. Wansley

The University

of

Tennessee

Breck Robinson

The University

of

Delaware

Abstract

In this paper we explore price and volume effects associated with the 199 I

creation of Standard &Poor's MidCap 400 index. Prior work on changes in the

composition

of

existing indices finds a significant price response to the announcement.

Various authors link the effect to price pressure, information, an outwardly shifting

demand curve for securities, and the increased attention that comes with inclusion in

an index. Using event study methodology, we find significant price and volume effects

during the two weeks leading up to the Standard &Poor's announcement, but no

significant effect in the two-day interval around the event. Apparently, information

leakage and/or anticipation preceded the creation

of

the index. The price run-up is

permanent since the positive abnormal returns leading up through the announcement

are not associated with significantly negative abnormal returns after the announce-

ment. In addition, MidCap stocks significantly outperform the market during the fifty-

two weeks following the announcement. Using cross-sectional regressions, we show

that these prior-period abnormal returns are positively related to abnormal volume and

institutional holdings. We also find that firms trading over-the-counter had larger price

run-ups than NYSE or AMEX firms.

I. Introduction

The announcement by Standard &Poor's (S&P) that it was creating a

MidCap index offers a unique opportunity to examine the effect on the stocks

composing the new index. The creation

of

a new index should provide no new

The authors express appreciation to Elliott Shurgin, Vice President for Index Products at Standard &Poor's,

for providing information on the composition on the MidCap index and for discussions on the release

of

information regarding the index. In addition, the authors aregrateful for comments on earlier drafts

of

this manu-

script from Harold Black, Philip Daves, Ray DeGennaro, Mike Ehrhardt, Delbert Goff, James Pawlukiewicz,

Ron Shrieves, and particularly Rob Hansen, the Editor. They are also thankful for comments received from

seminar participants at Babson College, the Office

of

the Comptroller

of

the Currency, Northeastern University,

the 1992 Southern Finance Association Annual Meeting, The University

of

Tennessee, and Wake Forest

University. The authors are responsible for any remaining errors.

329

330 The Journal

of

Financial Research

information about the firms selected for the index and, as such, should imply no

price reaction. However, prior work such as Harris and Gurel (1986) and

Woolridge and Ghosh (1986) consistently shows significant, positive reactions

when firms are added to existing indices such as the S&P 500 index and the Dow

Jones Industrial Average.

While previous studies recognize that these price effects occurfor existing

indices, they do not agree on their cause(s), and no study examines new indices.

Harris and Gurel (1986) and Lamoureux and Wansley (1987) attribute the price

effects around additions to the S&P 500 to a transitory price pressure effect. On

the other hand, Shleifer (1986) concludes that these price effects exist because the

long-run demand curve for securities is not perfectly elastic. These studies agree,

however, that one likely cause

of

the price change is the increased demand that

results when index funds and others add these securities to their portfolios. In

fact, Pruitt and Wei (1989) show that changes in institutional security holdings

are positively correlated with abnormal returns in response to S&P 500 additions.

They note, however, that the change in institutional holdings accounts for only

a small percentage

of

the increase in volume.

If

inclusion in the S&P MidCap causes asubstantial change in institution-

al following, apositive price response would be consistent with

Merton's

(1987)

theory

of

equilibrium pricing with incomplete information. In

Merton's

model, a

firm's

equilibrium rate

of

return depends, among other things, on the relative size

of

its investor base, or what Merton calls the "degree

of

investor recognition."

Finally, Dhillon and Johnson (1991) present evidence inconsistent with

both the price pressure and imperfect-substitution hypotheses. They find that

stock, bond, and call option prices increase for firms added to the S&P 500, while

put prices decrease. They interpret their evidence as consistent with an informa-

tion hypothesis, in which the addition to an index conveys positive information

to market participants.

We present new evidence to distinguish between information and price

pressure effects. If, as Dhillon and Johnson (1991) argue, price effects associated

with listing on the S&P 500 are related to information, these price effects should

also exist when the composition

of

the S&P MidCap is announced. On the other

hand,

if

price effects are related to changes in institutional holdings and price

pressure, long-term price effects would not be anticipated for MidCap firms, but

short-term price effects may exist. For instance, after the mid-April 1991 S&P

announcement that aMidCap index was forthcoming, several investment

companies suggested they would create funds based on the MidCap.' Just as with

the S&P 500, price pressure may exist for the MidCap because

of

the institutional

'PanAgora Asset Management had already announced plans to offer an institutional fund that would hold

MidCap stocks. State Street Bank &Trust had already announced plans to convert amiddle-capitalization fund

to follow the MidCap (Wall Street Journal, June

5,1991,

pp.

Cl,CI3).