Nikkei
The Nikkei 225 Reconstitution by Romain Boulanger ; 30 Apr 2015 ; HBR business case
Because the Nikkei 225 reshuffling is thought to induce inefficient prices, the arbitrageur
Taka Haneda believes he could squeeze profit opportunities out of it. Conversely, buy-andhold investors will probably encounter losses. Both will interact to make the nicest move.
Following the index reconstitution announcement, economics 101 state that the to-be-added large cap stocks will face an upward price pressure whereas deleted and remaining stocks will suffer from downside risk. However, shareholders of an index do enjoy zero tracking errors and will certainly wait until the effective day to rebalance. Therefore, as a trader at Goldman
Sachs, I would play the arbitrage game. I would provide liquidity to index investors by shorting freshly added stocks and buying excluded ones. Via this move, I would hope a forthcoming favorable reversal impact as I expect (perhaps wrongly) prices to return to normality. After all, at the announcement date, prices already reflected the health of the underlying company. Even more so, the Nikkei 225 is a closely monitored index. Bid-ask spreads are getting lower. Prices and volumes effects should then be more pronounced.
But this is not a foregone conclusion. Prices might not go back to normal. Indeed, the information theory suggests that index changes convey information about the affected stocks, causing “permanent” price movements. More specifically, addition candidates cause closer scrutiny by analysts and investors, greater institutional interest and, consequently, more public information (symmetrically, a liquidity drop is predictable for deleted stocks). New entrants will also very likely cherish their index position and could thus react proactively to keep it safe. As an investment banker at Goldman Sachs, I would then hedge my arbitrage using correlated stocks, still unaffected by the index redefinition.
This said, arbitrage opportunities hold
Because the Nikkei 225 reshuffling is thought to induce inefficient prices, the arbitrageur
Taka Haneda believes he could squeeze profit opportunities out of it. Conversely, buy-andhold investors will probably encounter losses. Both will interact to make the nicest move.
Following the index reconstitution announcement, economics 101 state that the to-be-added large cap stocks will face an upward price pressure whereas deleted and remaining stocks will suffer from downside risk. However, shareholders of an index do enjoy zero tracking errors and will certainly wait until the effective day to rebalance. Therefore, as a trader at Goldman
Sachs, I would play the arbitrage game. I would provide liquidity to index investors by shorting freshly added stocks and buying excluded ones. Via this move, I would hope a forthcoming favorable reversal impact as I expect (perhaps wrongly) prices to return to normality. After all, at the announcement date, prices already reflected the health of the underlying company. Even more so, the Nikkei 225 is a closely monitored index. Bid-ask spreads are getting lower. Prices and volumes effects should then be more pronounced.
But this is not a foregone conclusion. Prices might not go back to normal. Indeed, the information theory suggests that index changes convey information about the affected stocks, causing “permanent” price movements. More specifically, addition candidates cause closer scrutiny by analysts and investors, greater institutional interest and, consequently, more public information (symmetrically, a liquidity drop is predictable for deleted stocks). New entrants will also very likely cherish their index position and could thus react proactively to keep it safe. As an investment banker at Goldman Sachs, I would then hedge my arbitrage using correlated stocks, still unaffected by the index redefinition.
This said, arbitrage opportunities hold