Comovement of Newly Added Stocks with National Market Indices: Evidence from Around the World

Abstract

We document the prevalence around the world of increased stock price comovement experienced by companies when added to major indices, and shed new light on the causes of this phenomenon. Using newly-constructed and extensive data covering forty developed and emerging markets over the last decade, we document that in most, though not all, countries, when added to a major index, a firm’s return experiences a post-inclusion increase in comovement with the rest of the index, reflected in both a higher beta (especially if the pre-inclusion beta is less than one) and greater explanatory power of the market return (higher R2). Stock turnover and analyst coverage also typically increase upon inclusion. Using a variety of empirical tests, we find that the demand-based view of comovement (the category/habitat views of Barberis, Shleifer and Wurgler, 2005) provides a good explanation for many of our findings. Some results, though, suggest that information-related factors are also important.

Revised version of a paper formerly circulated as CEPR Discussion Paper: http://ssrn.com/abstract=1311176

Keywords: index inclusion, comovement

JEL Classification: G1, G3