Do Changes in Index Composition Affect the Stock Prices and Trading Volume? The Case of a Shariah-Compliant Index in Malaysia

Abstract

We investigate the effects of index revision on (i) stock performance as measured by stock prices movement and, (ii) stocks trading volume based on FTSE Bursa Malaysia EMAS Shariah Index. Based on the sample size of stock additions and deletions from 2007 to 2014, our findings indicate that the effects are significant on both the prices and trading volume. However, the effects on stock prices become insignificant in the long term in our sub-sample of stock additions with all newly added stocks without duplicated firms, firms that are added in or deleted from the same index more than once. This could be due to the reason that investors may not be familiar with these newly added stocks and as such would remain hesitant to purchase them despite the inclusions of the stocks to the index. Our findings also show that both the stock additions and deletions have a positive effect on trading volume in both the short and long runs. This is in contrary to the prediction of liquidity cost hypothesis that deletions could result in lower liquidity which leads to diminished trading volume in the long run. It is likely that investors in general have pessimistic expectations toward the deleted stocks; they were scrambling to sell those shares even a long time after the “change day”. Overall, our results imply that investors who are concerned with Shariah-compliant investments should monitor and be aware of the stock additions and deletions in the Shariah-compliant index to rebalance their investment portfolios from time to time to improve their investment returns, both in the short run and long run.