Reclassifications of Countries' Implication for Stock Returns: An Analysis of how Index Providers’ reClassifications of Countries Impact the Countries’ Stock Markets in the Surrounding Period

Kasper Juhl Nielsen & Kristian Kofoed Philippsen

Student thesis: Master thesis


Equity index providers such as MSCI, FTSE Russel and S&P Dow Jones classify countries as Developed, Emerging, Frontier or Standalone Markets. As countries develop, index providers often reclassify countries between their indexes. With the increased popularity of passive equity investments, such as ETFs and passive mutual funds, more passive capital flow than ever before is automatically moving along when countries are reclassified. The objective of this thesis is to investigate if abnormal returns and changes in the Country Risk Premium are occurring in the period around reclassifications by the three index providers. The study includes 77 reclassifications from 1997 to 2018. When countries are upgraded, this paper finds an underperformance relative to MSCI’s ACWI in the surrounding weeks of the reclassification, and relative to its country-specific required rate of return in the following year after the reclassification. When countries are reclassified to a more benchmarked index, the same results are found, however, when countries are reclassified to a less benchmarked index, a negative performance relative to the estimated required rate of return are found between the announcement and reclassification. Whether a country is reclassified to a more or less benchmarked index has a higher explanatory power on how the country’s stock market performs in the period from the announcement to reclassification than whether a country is up or downgraded. This is further supported by findings that suggest that the Country Risk Premium generally does not change as a result of up or downgrades.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final Thesis
Publication date2019
Number of pages130