The effect of inclusion and exclusion of stocks from the JSE small cap index on stock performance.

Abstract

Small-cap equities on the Johannesburg Stock Exchange (JSE) operate in a low-liquidity environment where pricing can be sensitive to index rebalancing activity. Despite the importance of these stocks for domestic capital formation, limited empirical work has examined how index revisions influence their performance. The study examined how the inclusion and exclusion of stocks from the FTSE/JSE Small Cap Index affects stock performance, focusing on both short- and long-term abnormal returns around index revision announcements. The study aimed to determine how inclusions and exclusions affect stock prices in the short and long term, and whether the two event types produce significantly different outcomes. A quantitative research design was employed, using secondary data from the Johannesburg Stock Exchange over the period 2013 to 2023. The event study methodology was applied, with a 125-day estimation window and event windows of [−10,+10] and [−20,+30], using the market model to estimate expected returns. Abnormal returns (AR), cumulative abnormal returns (CAR), and cumulative average abnormal returns (CAAR) were calculated and tested for statistical significance. The results showed that inclusions generated marginal and statistically insignificant positive returns, suggesting that market participants do not overreact to index additions. In contrast, exclusions led to significant negative abnormal performance in the short term, consistent with the price pressure and information hypotheses. Over longer horizons, inclusions exhibited gradual recovery and sustained positive cumulative returns, while exclusions continued to underperform, though the losses moderated over time. The findings indicate that the JSE Small Cap Index responds asymmetrically to index revisions, with stronger and more persistent effects for deletions than for additions. The study concludes that while index inclusions do not produce abnormal gains, exclusions trigger short-term inefficiencies that present both risks and opportunities for market participants. The study offers practical insight for investors and policymakers. Investors may treat exclusion announcements as actionable signals, as short-term selling pressure can create opportunities or highlight liquidity concerns. For regulators and the JSE, the results emphasise the vulnerability of smallcap stocks to order-flow shocks, reinforcing the need to monitor liquidity standards, indexreview practices and rebalancing procedures.