Abstract
This article extends recent research (Barberis et al., Citation2005) on the impact of index changes on stock comovement. Stocks that are added to the FTSE 100 comove more closely with the FTSE 100, whilst the reverse is found in stocks deleted from the FTSE 100. Consistent with previous research, these changes appear to have become larger over more recent years. As a result of the method by which changes are made to the FTSE 100, this article is able to distinguish between additions that are new firms and additions that have previously been constituents. There is a significant difference between these two sets of firms, both in terms of the change in comovement and the extent of their comovement after addition to the FTSE 100. Specifically, it is the change in comovement among firms that are new to the FTSE 100 that drives much of the overall increase in comovement among additions. This result implies that the change in comovement cannot be explained solely by the behavioural finance view of comovement and the associated impact of category or habitat traders.
Notes
1 Barberis and Shleifer (Citation2003) develop a model in which investors assign stocks to categories. As investors switch between categories, they create patterns in demand that generate return comovement within a category that is independent of cash-flow comovement. In addition, the reclassification of a stock into a new category increases the stock's comovement with that category.
2 This view would be consistent with the Chen et al. (Citation2004) argument that an asymmetry in the price effects of additions and deletions is due to increased monitoring and investor awareness, since these do not fall when a firm is deleted from an index.