IMPACT ON STOCK PRICE WITH CHANGES IN THE CNX NIFTY INDEX

A Proposal Presented to Professor Dr. Suveera Gill University Business School Panjab University, Chandigrah

On 11 September 2012

In Partial fulfillment of Masters of Business Administration (MBA)

By Sarabjit Singh

S.No.

Particulars

Page No.

Introduction
1.1 Changes in the Index 1.2 S&P CNX Nifty 1.3 Efficient Market hypothesis 1.4 Volatility

1 1 1 4 5 5 7 8 8 8 8 10 10 10 13 15

2 3 4 5

Review of Literature Need and Significance of the study Proposed Objectives of the study Research Design
5.1 Hypotheses of the study 5.2 sample selection 5.3 Sources of data 5.4 Period of study 5.5 Tools for analysis

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References Appendices

1 INTRODUCTION
1.1 Changes in the Index: Changes in an index are a regular phenomenon and they take place due to the inclusion and exclusion of stocks from the index. A stock index reflects the mood and direction of the overall market movements. The stock indices, apart from being an indicator of the market movements, serve as a bench mark for measuring the performance of stocks under that index. The stock indices are rarely static and their composition keeps changing so that the objectives behind the construction of indices are served. The changes might also be effected by other reasons like mergers and corporate restructuring which might cause some of the stocks to exit from the market. Although changes in an index like Nifty are a regular phenomenon, these changes have implications for the markets in general. When a stock is added to (or deleted from) the Nifty, the index will try to include it in their portfolio and these actions may induce buying/selling pressure and correspondingly, the price level is increased (decreased) and the volume of both types of stocks increased. 1.2 S&P CNX Nifty: National Stock Exchange (NSE) is a stock exchange located at Mumbai, India. It is the 16th largest stock exchange in the world by market capitalization and largest in India by daily turnover and number of trades, for both equities and derivative trading. Though a number of other exchanges exist, NSE and the Bombay Stock Exchange are the two most significant stock exchanges in India and between them are responsible for the vast majority of share transactions. S&P CNX Nifty, also called the Nifty 50 or simply the Nifty, is a stock market index, and one of several leading indices for large companies which are listed on National Stock Exchange of India, index based derivatives and index funds. Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a joint venture between NSE and CRISIL(Credit Rating and Information Services of India Ltd). (IISL) is India's first specialized company focused upon the index as a core product. IISL has a marketing and licensing agreement with Standard & Poor's for co-branding equity indices. 'CNX' in its name stands for 'CRISIL NSE Index'.

The present composition of the S&P CNX NIFTY is given in the table below. S&P CNX NIFTY COMPOSITIONS (as on 1-Sept-2012) Industry Company Name CEMENT AND CEMENT ACC Ltd. PRODUCTS CEMENT AND CEMENT Ambuja Cements Ltd. PRODUCTS PAINTS Asian Paints Ltd. BANKS Axis Bank Ltd. AUTOMOBILES - 2 AND 3 Bajaj Auto Ltd. WHEELERS BANKS Bank of Baroda ELECTRICAL EQUIPMENT Bharat Heavy Electricals Ltd. REFINERIES Bharat Petroleum Corporation Ltd. TELECOMMUNICATION BhartiAirtel Ltd. SERVICES OIL Cairn India Ltd. EXPLORATION/PRODUCTION PHARMACEUTICALS Cipla Ltd. MINING Coal India Ltd. CONSTRUCTION DLF Ltd. PHARMACEUTICALS Dr. Reddy's Laboratories Ltd. GAS GAIL (India) Ltd. CEMENT AND CEMENT Grasim Industries Ltd. PRODUCTS COMPUTERS SOFTWARE HCL Technologies Ltd. BANKS HDFC Bank Ltd. AUTOMOBILES - 2 AND 3 Hero MotoCorp Ltd. WHEELERS ALUMINIUM Hindalco Industries Ltd. DIVERSIFIED Hindustan Unilever Ltd. FINANCE HOUSING Housing Development Finance Corporation Ltd. CIGARETTES I T C Ltd. BANKS ICICI Bank Ltd. FINANCIAL INSTITUTION IDFC Ltd. COMPUTERS SOFTWARE Infosys Ltd.

CONSTRUCTION STEEL AND STEEL PRODUCTS BANKS Kotak Mahindra Bank Ltd. ENGINEERING Larsen & Toubro Ltd. AUTOMOBILES - 4 Mahindra & Mahindra Ltd. WHEELERS AUTOMOBILES - 4 Maruti Suzuki India Ltd. WHEELERS POWER NTPC Ltd. OIL Oil & Natural Gas Corporation Ltd. EXPLORATION/PRODUCTION POWER Power Grid Corporation of India Ltd. BANKS Punjab National Bank PHARMACEUTICALS Ranbaxy Laboratories Ltd. REFINERIES Reliance Industries Ltd. POWER Reliance Infrastructure Ltd. MINING Sesa Goa Ltd. ELECTRICAL EQUIPMENT Siemens Ltd. BANKS State Bank of India STEEL AND STEEL Steel Authority of India Ltd. PRODUCTS METALS Sterlite Industries (India) Ltd. PHARMACEUTICALS Sun Pharmaceutical Industries Ltd. COMPUTERS SOFTWARE Tata Consultancy Services Ltd. AUTOMOBILES - 4 Tata Motors Ltd. WHEELERS POWER Tata Power Co. Ltd. STEEL AND STEEL Tata Steel Ltd. PRODUCTS COMPUTERS SOFTWARE Wipro Ltd. (Source: NSE website, http://www.nse-india.com) Jaiprakash Associates Ltd. Jindal Steel & Power Ltd. 1.3 Efficient market hypothesis: Efficient market hypothesis states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the
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overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. The efficient market hypothesis (EHM) predicts that the security prices reflect all publicly available information. Therefore, one corollary of the EMH is that one can sell (or buy) large blocks of stocks nearer to the market price as long as one could convince other investors that one has no private or inside excess demand for a single security will be very elastic, and the purchase of a large number of shares will have no impact on price. The purpose of this research study is to analyze the impact of inclusion into or exclusion from the stock index of a certain stock on the price of the relevant stock. 1.4 Volatility: Volatility refers to the degree of (typically short-term) unpredictable change over time of a certain variable. Since it is a standard measure of financial vulnerability, it plays a key role in assessing the risk/return tradeoffs and forms an important input in asset allocation decisions. Volatility is caused by the random arrival of new information about the future returns from the stock, arbitrage (Arbitrage is the simultaneous buying and selling of an asset to profit from price discrepancies), technology, inflation and interest rates volatilities, etc. Volatility plays a key role in assessing risk/return trade off. Volatility is central to many investment decisions in new product areas and is the critical variable in options. The volatility of the underlying asset dictates the extent and likelihood of the options payout. Most option pricing models including Black Scholes require a Volatility input defined as Standard deviation of log relative prices. It is important to option traders because volatility is a measure of the possible price changes of the assets in the future.

2. REVIEW OF LITERATURE
A body of literature examining the effect of stock inclusions (exclusions) to (from) has the S&P 500 as the focal point. The extant literature provides conflicting evidence for the S&P 500 for various reasons. Shleifer (1986) investigated the index effect and examined the price impact related to changes in S&P 500 between 1966 and 1983. The study found that there was an abnormal price increase of 2.79 percent and the cumulative returns persisted. The returns were positively related
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to measures of buying index funds and the results were attributed to the downward sloping curves for stocks. Lynch and Mendehall (1997) documented significant post-announcement abnormal returns that were only partially reserved following the additions to or deletions from the S&P 500 index in their research. Their evidence of permanent trading volume contributing towards added stocks provides support for both the PPH and the imperfect substitute hypothesis. Dhillon and Johnson (1991), examined only the additions to the S&P 500 index during 1978-88 and found that price levels persisted for around 60 days after the announcement, which is inconsistent with PPH. Harris and Gurel (1986) found 3.13 percent abnormal returns resulting from additions to the S&P 500. This increase was almost reserved after two weeks and thus, they attributed the abnormal returns to the increased demand for the index funds. Their evidence is consistent with the price pressure hypothesis. Pruitt and Wei (1989) provided direct evidence that institutional investors cause for demand changes. The price pressure is attributed to institutional portfolio strategies that seek to match the S&P 500 index returns by purchasing the stocks newly added to the index. Machnes and Kula (2011) estimated the premium effect of the S&P 500 index after a newly stock appears on the index list. Most of the changes in the newly added (or removed) stock took place two months before official announcement of the updated list of companies on the index, and hence the liquidity of the stocks will increase and their price will rise. Index oriented institutional investors who choose to be linked to the TA25 index pay most of the premium. Traders who are familiar with the index effect buy stocks they expect to be on the index and short-sell stocks expected to be dropped, and thus make a profit from the index reputation. Jain (1987) found that the stocks added to S&P 500 experienced excess returns of 3percent on the announcement day and this excess returns were added to S&P supplementary indices. This study contested the PPH and downward sloping demand curve (DSDC) hypothesis and ascribed the excess returns to the information content hypothesis.
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In a series of articles Beneish and Whaley (1996, 1997, 2002) documented that excess returns associated with index revisions has increased from around 2.79% (during 1976-83) to 5.94 % (during 1989-95) to 8% (during 1996-2001) and they attributethis to the growing index fund industry in the U.S. Hedge and Mc.Dernott (2003) test for liquidity changes and they found a permanent increase in liquidity measured by decreased effective spreads, increased quote depth and as well as increase in volume. Vijaya and Vedpuriswar (2003) have investigated in their article The Dynamics around Sensex Reconstitutions the price effects for the sensex. Though this study reports a weak permanent effect for deletions, the researches pointed out that the study suffers from the problem of assumed announced dates as Bombay Stock Exchange (BSE) did not maintain a record of the exact announcement dates. Therefore, the study has limited research focus on account of uncertain announcement dates. In conclusion it is evident that the existing literature is more or less unanimous on the premise that index revisions are associated with price effects but the debate is whether the price effects are temporary or permanent and also there is disagreement on the explanations for these findings. In the broad sense this study is quite relevant to the present scenario, the share market is facing more volatility, and because of this investors have lost their confidence due to more ups and downs in the market, and also much of the work is not done in this case. So it is imperative to study the impact of the NSE on the share prices of various companies which are included or excluded form the NSE and the volatility

3. NEED FOR THE STUDY

There is a need to know how the market moves before and after the effect of inclusion or exclusion of particular company scrip. Besides, there is a need to measure the impact and study about how the market is good to the investor. This study aims to analyze the excess returns for the stocks before and after the inclusive and exclusive period for S&P CNX Nifty. The results of the study will be useful for the National Stock Exchange (NSE), index fund manager and broadly to the discipline of the market efficiency. The result of the study will be useful for index funds and self-indexers, who balance their portfolios in line with the changes in the index. Local investors,foreign investors and portfolio
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managers are also gets benefits with this study. This study also contributes to the existing literature so also beneficial for the academicians.

4. PROPOSED OBJECTIVES OF THE STUDY

The main objectives of this study are as follows: 1. To analyze the effects of changes in both inclusion and exclusion of companies in S&P CNX Nifty companies during the period from January 2005 to December 2011. 2. To study the volatility of stocks of companies included and excluded in Nifty during the study period.

5. RESEARCH DESIGN
5.1 Hypotheses of the study
The following hypotheses are tested in this study: H1: There are no excess returns recorded by Nifty companies in the pre-announcement window. H2: There are no excess returns recorded by Nifty companies in the post-effective window. H3: There is no impact on the volatility of the companies included and excluded in Nifty on announcement day. H4: There is no impact on the volatility of the companies included and excluded in Nifty on effective day.

5.2 Sample Selection: The purpose of this study is to analyze the price pressure effect on S&P
index. The sample for this study comprised all changes on account of inclusion and exclusion in the Nifty during the period January 2005 to December 2011. The criteria for selection of the stocks in the sample were: Changes in the Index due to corporate restructuring like Mergers and Acquisitions were not taken as the sample. Non-availability of announcement or effective dates.
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Finally, it resulted in a sample of 20 exclusions and 20 inclusions for the study. The following table represents the stocks which were included and excluded during the study period: S. No 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 Company Name Asian Paints Bank of Baroda Grasim Sesa Goa Dr. Reddy Bajaj-Auto Kotak Bank IDFC JP Associate Jindal Steel Reliance Caital Reliance Power DLF Cairn Idea NTPC RPL STER Jet Airways Reliance Communication Reliance Communication Relaince Power Suzlon Unitech Idea ABB Grasim Nationalum Tata Communivcation RPL Satyam Computer Dr. Reddy
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Date of Inclusion 27/4/2012 27/4/2012 25/3/2012 1/10/2010 1/10/2010 1/10/2010 8/4/2010 22/10/2009 22/10/2009 17/6/2009 12/1/2009 10/9/2008 14/3/2008 12/12/2007 12/12/2007 24/9/2007 4/4/2007 4/4/2007 26/9/2006 1/9/2006 -

Date of Exclusion 27/04/2012 27/04/2012 25/03/2012 1/10/2010 1/10/2010 1/10/2010 8/4/2010 22/10/2009 22/10/2009 17/6/2009 12/1/2009 10/9/2008

33 Glaxo 34 Hind Pertro 35 MTNL 36 Dabur 37 Orient Bank 38 Jet Airways 39 SCI 40 Colgate-Palmolive (Source: NSE website. http://www.nse-india.com)

14/3/2008 12/12/2007 12/12/2007 24/9/2007 4/4/2007 4/4/2007 27/6/2006 26/9/2005

5.3 Sources of Data: The study depended on the secondary data and the required data were
collected from websites like http://www.nseindia.com, http://www.yahoofinance.com,http://www.moneycontrol.com ,and Prowess Corporate database.

5.4 Period of the study: The period for this studystarts from 1 January 2005 and ends with 31
December 2011. The study covers only seven years. The analysis period covers 21 days window period, that is, 10 days before and after effective date. Announcement day means, NSE may announce to the press that this company is going to be excluded or included on the particular date.

5.5 Tools used for Analysis:

In order to analyze the price pressure effects of changes under both inclusion and exclusion in S&P CNX Nifty, the following tools will be used. 5.5.1 Tools for analyzing the volatility in returns of included and excluded companies: GARCH Model: GARCH model was developed by Bollersler (1986) as a generalized version of Engles (1982) Autoregressive conditional heterscedasticity (ARCH). In the GARCH model the conditional variance at time t depends on the past values of the squared error terms and the past conditional variances. GARCH forecast variance as a weighted average of three different variance forecasts. One is the constant variance that corresponds to the long run average, 2nd is the forecast made in previous years, the 3rd is the new information that was not available when the previous forecasts was made.

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Negative returns seemed to be more important predictions of volatility than positive returns. Large price decline forecasts greater volatility than similar large price increase.
12 = 0+12t-1 + --------P2t-p (1)

(as used by Selvam, Indhumathi and Lydia for measuring volatility in Impact on Stock price by the Inclusion to and Exclusion form CNX Nifty Index) where, 2t-1 information available on t-1 day; = constant; and = coefficient on a time period.

5.5.2 Tools for analyzing the price effect on included and excluded companies: I. Abnormal Returns: To examine whether the float adjustment causes abnormal returns. Abnormal returns (AR) are calculated as the excess returns earned by a sample stock over the bench mark portfolio. ARjt= Rjt j Rmt ARji = the abnormal return of the particular stock j on the day t; Rjt = the return of the particular stock j on the day t; = the average returns of the firm compared to the market average; = the market risk of this stock; and Rmt = the returns on a market index for day t. II. Mean Abnormal Returns (MAR): Mean abnormal returns is the average of the excess returns across the N firms on the day t.
N

MARt = 1/N ARj,t

j=1

III.

Announcement price reaction of the firms added to the CNX Nifty

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i.

Cumulative Abnormal Return (CAR): A cumulative abnormal return (CAR) is defined as the sum of all the excess returns over the window of interest. The formula for calculating CAR is as follows:
T2

CARj,t = ARj,t
T1

ii.

Mean Cumulative Abnormal Returns (MCAR): The average of the CAR across the observations is a measure of the abnormal performance over the event period. The formula for calculating MCAR is as follows:
N

MCARt = 1/NCARj,t
j=1

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6. REFRENCES
Dhillon, U., and Johnson, H. (1991).Changes in the S&P 500.Journal of Business,64(1) 75-85. Harris, L., and Gurel, E. (1986). Price and volume effects associated with changes in the S&P 500 list: New evidence for the price pressures. Journal of Finance, 41(4),815-829. Lynch, A., and Mendenhall, R. (1997). New evidence on stock price associated with changes in the S&P 500 index. Journal of Business, 70(3).351-383. Shleifer, A. (1986). Do demand curves foe stocks slope down? Jouanal of Finance, 41(3), 579590. Vijaya, B.M., and Vedpuriswar (2003).The dynamics around sensex reconstitutions.ICFAI Journal of Applied Finance,9(4), 5-13 Jain, P.C. (1987). The effects on stock price of inclusion or exclusion from S&P 500. Financial Analysts Journal, 43(1),58-65 Platikanova,P.,(2008). Long-term price effect of S&P 500 additions and earnings quality.Financial Analysts Journal64, pp. 62-76 Denis, D.K., et.al. S&P 500 index additions and earnings expectations. The Journal of Finance 58,pp.1821-1840 Chen, H., Noronha and V. Singal (2004). The price response to S&P 500 index additions and deletion: Evidence of asymmetry and a new explanation. The Journal of Finance 59,pp.19011929 Beneish,M.,and Whaley, R. An anatomy of the S&P game: The effect of changing the rules. The Journal of Finance 51,pp.1909-1930 Barberis, N., A. Shleifer, and J. Wurgler, (2005), Comovement, Journal of Financial Economics75, 283-317. Becker-Blease, J.R., and D.L. Paul, (2006), Stock Liquidity and Investment

Opportunities:Evidence from Index Additions, Financial Management 35(3), 35-51.

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Blitzer, D.M., (2003), Standard & Poors U.S. Indices: the S&P 500, S&P MidCap 400 and S&P SmallCap 600, Standard and Poors Corporation. Bos, R., and M. Ruotolo, (2000), General Criteria for S&P U.S. Index Membership, Standard and Poors Corporation. Elliott, W.B., B.F. Van Ness, M.D. Walker, and R.S. Warr, (2006), What Drives the S&P 500 Inclusion Effect? An Analytical Survey, Financial Management 35(4), 31-48. Elliott, W.B., and R.S. Warr, (2003), Price Pressure on the NYSE and Nasdaq: Evidence from S&P 500 Index Changes, Financial Management 32(3), 85-99. Hegde, S.P., and J.B. McDermott, (2003), The Liquidity Effects of Revisions to the S&P 500 Index: An Empirical Analysis, Journal of Financial Markets 6, 413-459. Vijh, A.M., (1994), S&P 500 Trading Strategies and Stock Betas, The Review of FinancialStudies 7, 215-251. Wall Street Journal, (1995), S&P Plans Changes in Stocks for its Index, October 19, C21. Wurgler, J., and E. Zhuravskaya, (2002,) Does Arbitrage Flatten Demand Curves for Stocks?The Journal of Business 75, 583-608. Brown, S. J. and J. B. Warner, (1980).Measuring security price performance, Journal of FinancialEconomics 8, 205-258. Cha, H. and B. Lee, (2001). The market demand curve for common stocks: Evidence from equity mutual fund flows, Journal of Financial and Quantitative Analysis 36, 195-220. Chung, R. and L. Kryzanowski, (1997). Analyst following and market behavior around TSE300 index revisions, in SBF Bourse de Paris, ed.: Organization and Quality of EquityMarkets (Presses Universitaires de France, Paris).

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7.APPENDIX
Tentative Work Plan
2012 Activity/ Month Finalizing Research Topic Review of Literature Project Synopsis Data Collection Data Analysis Compilation of Results Final Research Report 2013

August September October November December January Feburary March

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