This paper examines the effect of changes in the KOSPI 200 index. We find evidence of permanent price effects and partial return reversal for the event stocks. Trading volumes tend to significantly increase during the event period and remain relatively higher than before the event. We also find some evidence of the existence of anticipatory trading effect before the effective dates and volatility effect. The results show that the abnormal return still exists even after adopting factor models and excluding newly added stocks. The indexing methodology of KOSPI 200 conveys the valuable information that the added stocks showed good performance and better earnings relative to the market average and the deleted stocks showed vice versa. In conclusion, member changes in the KOSPI 200 index are not information-free events.
The addition or deletion of a stock from an index is important not only to index basket traders who must rebalance their portfolios, but also to arbitrageurs who exploit these opportunities to make a profit. The index change effect was first investigated by Shleifer, 1986 and Harris and Gurel, 1986 and Jain (1987). The effect has been extensively documented in numerous other studies of abnormal stock price movement around the event period that cannot be explained by the efficient markets hypothesis. However, questions about what drives stock prices and what affects the behavior of individual stocks remain unanswered.
Most research on the index change effect has focused on the S&P 500. Starting in the mid-1990s, some studies began examining other indices (see, e.g., Beneish and Gardner, 1995 and Chen, 2006) and in recent years researchers have started to study indices of developed markets outside the U.S. (see, e.g., Liu, 2000, Masse et al., 2000, Masse, 2007 and Qiu and Pinfold, 2008). However, research on indices of emerging markets is still in its early stages (see, Bildik and Gulay, 2008 and Elayan et al., 2000).
The index change effect is an important and critical issue in Korea since asset size in Korea Stock Exchange Price Index (KOSPI) 200 and the number of index funds are growing quickly (depicted in Fig. 1), and the Korean stock market is on the verge of transitioning from an emerging market to a developed market.1 Moreover, the KOSPI 200 index itself is meaningful to researchers studying derivative markets since the futures and options contracts underlying KOSPI 200 are some of the most active in the world. The KOSPI 200 index effect is therefore deserving of attention from academics and practitioners.
Full-size image (39 K)
Fig. 1.
KOSPI 200 index fund market trend.
Source: Zeroin Inc. (www.funddoctor.co.kr).
Figure options
This study investigates the index change effect of the KOSPI 200 index in terms of abnormal return, volume and risk. We first calculate abnormal return using a simple model and then compare the results to those obtained when using one-factor and three-factor models. We examine the abnormal volume effect using relative dollar volume ratio measure. In addition, we attempt to explain the change effect by analyzing the volatility and beta of event stocks. We also examine the index change effect by focusing on stocks newly added to the index while excluding the prior constituents. From our results, we conclude that changes in the KOSPI 200 index show the same abnormal return behavior as has been found in data for the U.S. and other developed markets.
Our study is important for several reasons. Firstly, the present study represents the first attempt at providing a comprehensive analysis of index change effects within the Korea Stock Market. Secondly, the results of this research offer a meaningful counterpoint to results obtained for developed countries, such as analyses involving the S&P 500 by comparing the indexing methodology. Thirdly, we try to explain the abnormal return of event stocks by volatility changes and information content hypothesis adoption. Lastly, we analyze the addition effect by restricting part of the analysis to focus solely on newly added stocks.
The study is organized as follows. In Section 2 we discuss the relevant existing literature and briefly describe the motivations behind our empirical predictions. Section 3 describes the data and methodology. We analyze the index change effect by abnormal return and volume in Section 4. In Section 5 we report results of additional tests and offer some discussion of our findings. Our conclusions are presented in Section 6.
This study seeks to sketch out the effect of regular changes in the KOSPI 200 index from the perspectives of abnormal return, volume and risk. The evidence obtained here serves as a stepping stone for deeper analysis of the index change effect within emerging markets.
The results show that there is some evidence of permanent price effects but no full return reversal found, particularly during the more recent period studied. We also find the trading volumes tend to significantly increase after the announcement date and remain relatively higher than before the event. We also find that an anticipatory trading effect exists before the effective dates, but that this trading has no predictive power for future return. The results show that the abnormal return still exists after adopting factor models. This abnormal return also remains after excluding newly added stocks. Based on our findings, we can tentatively conclude that changes in the KOSPI 200 index result in the same abnormal return behavior as reported in studies using data from the U.S. and other developed markets. From our results, we conclude that KOSPI 200 index changes convey favorable information on added stocks and unfavorable information on deleted stocks.
