Revisiting the S&P 500 Index Inclusion Effect: An Empirical Study on the Persistence of Abnormal Returns and the Influence of Firm Characteristics Over the Past 25 Years

Abstract

This study investigates the S&P 500 index inclusion effect over a 25-year period, analyzing how abnormal returns around announcement and inclusion events have evolved in their timing, magnitude, and underlying dynamics. By combining event-time analysis with firm-size adjusted abnormal returns and cross-sectional regressions across multiple event windows, the findings presented offers a nuanced perspective on the phenomenon. The empirical findings confirm that while the index inclusions, aligned with existing literature generate significant positive abnormal returns, particularly around the announcement date, the effect has become increasingly front-loaded and fragmented. Positive abnormal returns are more concentrated in the pre-announcement window, especially in the 2020s, thus reflecting a greater market anticipation of upcoming index inclusions. Post-inclusion reversals remain significant for smaller companies in the sample, measured by market capitalization at time of inclusion, but are more muted for larger firms, thus suggesting that firm-size and relative volatility strongly impact the observed abnormal returns. These results primarily support the demand-based theories, particularly the Price Pressure Hypothesis, while offering limited support for the information-based ones. Consequently, the study challenges the diminishing return effect, showing that the S&P 500 index inclusion effect persists, although in a more time-sensitive, firm-specific, and possibly more predictable form, within a financial market environment increasingly defined by the rise of passive investment flows.