The effect of inclusions and exclusions of stocks from the JSE Top 40 and FTSE/JSE mid cap indices on liquidity.
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Date
2022
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Abstract
The inclusion and deletions of stock from the equity indices provide an important insight into
a company’s performance. There is evidence there are no studies on the effects of inclusions
and exclusions of liquidity in a South African market as previous studies in such a market
relates to price and index rebalancing effects as a result of inclusions and exclusions to the
FTSE/JSE and JSE Top 40. The insights that international studies provide are useful and these
effects explored in a South African context would be useful and close the gap in this area of
research and this is one of the main aims of the study. The lack of studies analysing the impact
on liquidity as a result of inclusions and exclusions to the JSE Top 40 and Mid Cap Index is a
disadvantage to South African investors, companies, and regulators. Therefore, the primary
objective of this study is to investigate the effect of inclusions and exclusions on the Top 40
and Mid Cap Index on liquidity as well as to determine how does the size of a firm impacts the
liquidity effects of an index addition or deletion.
The paper seeks to determine these effects by using an event study methodology by regressing
a number of different liquidity proxies (turnover, aggregate turnover, bid-ask spread,
percentage spread and Amihud Illiquidity measure) using daily data for the companies that
have been included and excluded from the indices. This study analyses 44 inclusions and
exclusions on the JSE Top 40 and 73 and 81 inclusions and exclusions on the Mid Cap index
from January 2010 to December 2020.
The results from this study provide important insights into the effects of index revisions and
firm size on liquidity. For stocks that form part of the inclusions to an index, there in an increase
in liquidity as a result of the increased trade after the stock was included in the Top 40 and
provides support from the Downward Sloping Demand Curve Hypothesis, Price Pressure
Hypothesis and Liquidity Cost Hypothesis. For exclusions stocks, shows a decrease in volume
traded and increasing spreads for the Top 40 and indicates that this diminished liquidity
observed for such companies that find themselves excluded in both the Top 40 and Mid Cap
indices which supports the information cost liquidity hypothesis.
Description
Masters Degree. University of KwaZulu-Natal, Durban.