Comovement After Joining an Index: Spillovers of Nonfundamental Effects

Abstract

This study considers the case of two overlapping categories in the context of recent category models. Specifically, we examine whether investor sentiment and market frictions specific to one category can affect the returns on assets belonging to the other category. With recent additions of several real estate investment trusts (REITs) into general stock market indices as a natural experiment, we find support for spillovers of such nonfundamental effects, as evidenced by the increased return correlation between REITs that remain outside the index and the index stocks. Further analysis reveals that market frictions play a greater role than investor sentiment.

The Consequences of REIT Index Membership for Return Patterns

“…To our knowledge, we are the first to compare these two effects of shared index membership and partial index membership in a pair of U.S. REIT stocks. Our findings are qualitatively consistent with the evidence for spillover effects from index stocks to nonindex stocks described in Ambrose, Lee and Peek (). While Ambrose, Lee and Peek () focus primarily on the inclusion event, we extend their evidence to the steady state that evolves over time after the initial inclusion effect.…”

“…We also find that the returns of firm pairs where only one firm is part of an index are more correlated than the returns from pairs where no constituent firm is part of an index. This latter finding confirms earlier evidence on spillover effects from index firms to nonindex firms (Ambrose, Lee and Peek ).…”

Are REITs real estate? Evidence from international sector level data

“…Hoesli and Serrano (2007), in turn, find evidence of a decreasing correlation between the securitized real estate and equity markets. Nevertheless, some studies show that the comovement between REIT returns and general stock market returns has increased recently (Ambrose et al, 2007;Simon and Ng, 2009).…”

Index composition changes and the cost of incumbency

“…If, for some reason, a particular industry is no longer economically important, the number of firms in this industry would be reduced within the index. If a firm is removed from the index, it is replaced by a firm from the replacement pool, which may or may not come from the same sector.5 The model is similar to that employed byAmbrose et al (2007).6 If the added firm, D, has a market value of, say, $10 m, then the weights of the incumbents will increase. However, as shown inTable 1Panel B and Panel C, the market values of added firms are usually larger than the market values of the replaced firms; as a result, the weights of the incumbents will drop following index additions.…”