Market Reactions to Changes in the S&P/TSX SmallCap Index

Earlier studies find inconsistent results about market reactions to changes in large cap and small cap stock indexes. This study extends the literature by examining stock price and trading volume reactions to changes in the Canadian S&P/TSX SmallCap index, and offers several conclusions. First, consistent with previous studies, we find that the way a stock is added to or removed from the index makes a large difference. Specifically, pure additions to the S&P/TSX SmallCap index show significant positive cumulative abnormal returns in the period before and on the announcement day. In contrast, downward additions experience a significant negative abnormal return on the effective day. Similarly, pure deletions show significant negative cumulative abnormal returns before the announcement day, as well as on both the announcement and effective days. On the other hand, upward deletions do not experience significant abnormal returns during the event period.Second, we find a permanent stock price increase for pure additions to the S&P/TSX SmallCap index. Pure additions also tend to experience an increase in trading volume and decline in the relative bid-ask spread. In contrast, pure deletions show a permanent price decline that is partially reversed immediately after the effective day.Third, the significant abnormal trading volume on the effective day considerably exceeds the significant abnormal trading volume on the announcement day for all groups. This could be explained by the trading behavior of index funds that buy additions and sell deletions on the effective day near closing price to minimize tracking error