MARKET REACTION TO THE NASDAQ Q-50 INDEX. A Project. Presented to the faculty of the College of Business Administration

Transcription

1 MARKET REACTION TO THE NASDAQ Q-50 INDEX A Project Presented to the faculty of the College of Business Administration California State University, Sacramento Submitted in partial satisfaction of the requirements for the degree of MASTER OF BUSINESS ADMINISTRATION (Finance) by Yi-Chi Huang SPRING 2014

2 MARKET REACTION TO THE NASDAQ Q-50 INDEX A Project by Yi-Chi Huang Approved by:, Committee Chair Eric C. Lin Date ii

3 Student: Yi-Chi Huang I certify that this student has met the requirements for format contained in the University format manual, and that this Project is suitable for shelving in the Library and credit is to be awarded for the Project. Monica Lam, Ph.D. Date Associate Dean for Graduate & External Programs College of Business Administration iii

4 Abstract of MARKET REACTION TO THE NASDAQ Q-50 INDEX by Yi-Chi Huang How the information from the market indexes is interpreted is the most concerned topic to the investors and the analysts. The public is not only the reactor, but also the observer to others reaction. Market reaction to one of the major indexes, the NASDAQ Q-50 Index, is the main issue of this study. Prior research on S&P 500 Index s inclusion reach many impressive conclusions through different hypotheses. However, few studies have focused their attention on the NASDAQ market, which is as important as the Standard and Poor s. Therefore, this study focused on discussing the market s reaction toward the NASDAQ Q-50 Index to see how the information reveal is going to affect the market. By following Chen et al. (2004) study, this study proposed to examine the change of abnormal return and the shadow cost before and after the inclusion period to verify the hypothses., Committee Chair Eric C. Lin Date iv

5 TABLE OF CONTENTS Chapter 1. INTRODUCTION LITERATURE REVIEW... 2 Investor Awareness and the Price Response... 2 Reveal of Information BACKGROUND OF THE STUDY HYPOTHESES METHODOLOGY RECOMMENDATION DISCUSSION... 8 Appendix A... 9 References v

6 1 Market Reaction to the NASDAQ Q-50 Index Introduction Regarding with the complexity of the information environment, it is always important to the public how the investment information has be interpreted. The market reaction to the information changes is an important issue for different stock markets analyses. There are three major stock exchange markets in the United States: the Standard and Poor s, Dow Jones, and the NASDAQ. Prior studies paid lots of efforts on one of the Standard and Poor s main index S&P 500 Index, and tried to interpret the messages that come from it. It is always interesting to see how the messages deliver to the investors and the analysts and how they react to the events. However, few studies are going with the indexes of the NASDAQ. For example, the NASDAQ Q-50 Index has a regularly scheduled re-ranking of their indexes each year to ensure that the securities are accurately included. This characteristic is what S&P 500 Index does not have. Therefore, this study would like to apply the methodology to the NASDAQ Q-50 Index, which is the very first step going into the NASDAQ indexes. The objective of this study is to explore the NASDAQ Q-50 Index showing any informative forecasting to the future stock market.

7 2 Literature Review Investor Awareness and the Price Response Since Chen et al. (2004) proved the investor awareness caused an asymmetric price effect to the additions and deletions to S&P 500 Index, numerous researches show a firm s addition to S&P 500 Index had more positive effect to a stock s price than a firm s deletion did. The shadow cost was diminished from the information reveal to investors and caused permanent price effect to the addition firms but not to the deletion firms. Zhou (2011) examined the price effects in investor awareness of subgroups of S&P 500 inclusions. It takes a closer look on the firms added characteristics. The pure and new-entry additions received higher analyst coverage than the upward and reentry additions did. The pure and new-entry addition also experienced permanent price increase. However, the price effect on the upward and reentry additions were temporary. Baran and King (2012) supported the investor awareness hypothesis by examining the cost of capital for additions and deletions to the S&P 500 Index. Through multivariate analysis, the authors took a further step in stating the changes of the cost of capital for addition firms can result in an increase in liquidity, a decline in shadow cost and large firm size. However, the deletion firms only experienced the leverage of the change in cost of equity, neither the liquidity nor the firm sizes were affected. This asymmetry change demonstrates that the inclusions benefit more from the reduction of cost of capital. Moreover, Kamal et al. (2012) brought up the idea of the information environment change resulted in reduced abnormal returns after the year The events like implementation of Regulation FD, adoption of decimalization and

8 3 implementation of SOX caused reduced abnormal returns and let the information asymmetry of the index inclusion event diminished. Reveal of Information Besides the investor awareness hypothesis, Zhang et al. (2010) provided several results to show the analysts optimistic responds to S&P 500 inclusion announcement. From the properties of analysts earnings estimates and the responds to surrounding the announcement, it was obvious to see the analysts behaviors were affected by the announcement. It is also consistent with Denis et al. (2003) research that S&P 500 inclusion announcement was not an information-free event. Denis et al. (2003) found the earnings per share of newly added to the S&P 500 Index rose because inclusions in the Index lead to closer scrutiny to the public then lead to better performance. Cai (2007) follows Denis et al. (2003) and used the announcement price reaction of the industry and firm sizes to address the finding that the additions information itself was the result of the better performance than the cause of the better performance.

9 4 Background of the Study The NASDAQ Q-50 Index includes 50 non-financial domestic and international securities listed on the NASDAQ Stock Market ranked by market capitalization. It is created to track the performance of securities that are next-eligible for inclusion into the NASDAQ-100 Index. As a signal call of adding into the NASDAQ-100 Index, the composited companies in the NASDAQ Q-50 Index reflect several main industries in the world like computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. The index does not include financial companies, thus the companies to be eligible for including in the NASDAQ Q-50 Index, a security must be listed on the Nasdaq Stock Market and meet the following eligibility criteria: 1. The security must be of a non-financial company. 2. The security must have average daily trading value of at least 200,000 shares. 3. If the issuer of the security is organized under the laws of a jurisdiction outside the U.S., then such security must have listed options on a recognized options market in the U.S. or be eligible for listed-options trading on a recognized options market in the U.S.; 4. The issuer of the security may not have annual financial statements with an audit opinion that is currently withdrawn; 5. The issuer of the security must have "seasoned" on NASDAQ or another recognized market (generally, a company is considered to be seasoned if it has been listed on a market for at least two years; in the case of spin-offs, the

10 5 operating history of the spin-off will be considered); and if the security would otherwise qualify to be in the top 25% of the securities included in the Index by market capitalization for the six prior consecutive month-ends, then a one-year "seasoning" criterion would apply. (see Appendix for more information on the eligibility criteria) The NASDAQ Q-50 is a market capitalization-weighted index. The calculation of the Index value uses the aggregate value of the Index share weights, which is the Index Shares, of each security multiplied by its Last Sale Price, then divided by the divisor of the Index. The formula for index value is as following: Index Value = Aggregate Adjusted Market Value Divisor The formula for the divisor is as following: Divisor = Market Value after Adjustements Market Value before Adjustments Divisor before Adjustments The NASDAQ Q-50 Index began on October 10, 2007 at a base value of The composition of the NASDAQ Q-50 Index is reviewed on a quarterly basis in March, June, September and December. It is subjected to a quarterly evaluation and the review for eligible NASDAQ-100 Index Securities is performed on a monthly basis. Under this circumstances, it is possible that a security may be added to the NASDAQ- 100 Index intra-quarter without being a constituent of the NASDAQ Q-50 Index at the time of addition to the NASDAQ-100 Index.

11 6 Hypotheses The NASDAQ establishes the NASDAQ Q-50 Index to follow the next-eligible securities of the NASDAQ-100 Index. As one of the major indexes in the market, it will be interesting to explore the possibility of the information revealing from the NASDAQ Q-50 Index. It seems like an outpost to be ready to go into a battlefield. Although the NASDAQ stated that the selection of the Indexes inclusions follows the market capitalization, it is worthly to find out the relationship between the inclusions announcements and their stock prices. Ample studies regarding with different variables researches show the S&P 500 Index inclusions reveal information to the market. In this study, I followed the previous literatures and wish to solve and clarify if the inclusion to the NASDAQ Q-50 Index works the same. Firstly, understanding how the added firms to the NASDAQ Q-50 Index draw the investors recognition and are reacted on their liquidity and prices. Second, understanding the inclusions to the NASDAQ Q-50 Index whether itself is an information-free event. In sum, the followings are the null hypotheses: H 01 : The trading volume and price of stocks do not react to the addition event to NASDAQ Q-50 Index. H 02 : The inclusion announcements of addition to NASDAQ Q-50 Index are information-free events.

12 7 Methodology Recommendation By following the recent inclusions announcements in press, the firms that are added to and deleted from the NASDAQ Q-50 Index can be collected. In accordance with Chen et al. (2004), the estimates of shadow cost before and after index change can help to see the relation between the abnormal return and the shadow cost. With Chen et al. (2004) extension of Merton s (1987) investor recognition hypothesis, the formula to calculate the shadow cost of the NASDAQ Q-50 Index should be: Shadow Cost = Residual Standard Deviation NASDAQ Q-50 Index Market Cap Firm Size Number of Shareholders' After calculating the change of a firm s shadow cost, this change can help in regression analysis to find the performance of a firm s abnormal return. In the meanwhile, according to Denis et al. (2003), the data of pre-inclusions and post-inclusions earnings per share (eps) help to determine whether the event itself is information-free. Following the Denis et al. (2003), the forecasting period will be focus on from three months prior to the current year to the end of the current year. By conducting the analysis of median eps forecasts, I expect an added firm s eps in the experiment periods will be consistent with its eps before going into the NASDAQ Q-50 Index.

13 8 Discussion I have motivated from the previous S&P 500 Index research to estimate the possibility of other indexes as important as S&P 500 Index can have the similar conclusion to the inclusion events. It will be interesting either of the results is similar or totally different in some ways. The methodology in this study will help to test the hypotheses. While examining whether the inclusions performance is affected after adding into the NASDAQ Q-50 Index, the eps forecasts have a closer look on the investors expectation. Moreover, the measures like liquidity and the stock price can see as the indication of how much the investors recognition of the inclusions to the NASDAQ Q-50 Index. I wish this study can provide the mass reference for investing the potential stocks.

14 9 Appendix A Table A1: Eligibility of being ranked in the NASDAQ Q-50 Index. (The criteria are retrieved from Initial Eligibility Criteria: The security U.S. listing must be exclusively on the Nasdaq National Market (unless the security was dually listed on another U.S. market prior to January 1, 2004 and has continuously maintained such listing); The security must be of a non-financial company; The security may not be issued by an issuer currently in bankruptcy proceedings; The security must have average daily trading volume of at least 200,000 shares; If the issuer of the security is organized under the laws of a jurisdiction outside the U.S., then such security must have listed options on a recognized options market in the U.S. or be eligible for listed-options trading on a recognized options market in the U.S.; Only one class of security per issuer is allowed; The issuer of the security may not have entered into a definitive agreement or other arrangement which would likely result in the security no longer being Index eligible;

15 10 The issuer of the security may not have annual financial statements with an audit opinion that is currently withdrawn; The issuer of the security must have "seasoned" on NASDAQ or another recognized market (generally, a company is considered to be seasoned if it has been listed on a market for at least two years; in the case of spin-offs, the operating history of the spin-off will be considered); and If the security would otherwise qualify to be in the top 25% of the securities included in the Index by market capitalization for the six prior consecutive month-ends, then a one-year "seasoning" criterion would apply. Continued Eligibility Criteria: The security U.S. listing must be exclusively on the Nasdaq National Market (unless the security was dually listed on another U.S. market prior to January 1, 2004 and has continuously maintained such listing); The security must be of a non-financial company; The security may not be issued by an issuer currently in bankruptcy proceedings; The security must have average daily trading volume of at least 200,000 shares (measured annually during the ranking review

16 11 process); If the issuer of the security is organized under the laws of a jurisdiction outside the U.S., then such security must have listed options on a recognized options market in the U.S. or be eligible for listed-options trading on a recognized options market in the U.S. (measured annually during the ranking review process); The security must have an adjusted market capitalization equal to or exceeding 0.10% of the aggregate adjusted market capitalization of the Index at each month- end. In the event a company does not meet this criterion for two consecutive month-ends, it will be removed from the Index effective after the close of trading on the third Friday of the following month; and The issuer of the security may not have annual financial statements with an audit opinion that is currently withdrawn.

17 12 References Baran, L., & King, T. D. (2012). Cost of Equity and S&P 500 Index Revisions. Financial Management, 41, Cai, J. (2007). What s in the News? Information Content of S&P 500 Additions. Financial Management, 36, Chen, H., Noronha, G. and Singal, V. (2004). The Price Response to S&P 500 Index Additions and Deletions: Evidence of Asymmetry and a New Explanation. The Journal of Finance, 59, Denis, D. K., McConnell, J. J., Ovtchinnikov, A. V. and Yu, Y. (2003). S&P 500 Index Additions and Earnings Expectations. The Journal of Finance, 58, Kamal, R., Lawrence, E. R., McCabe, G. and Prakash, A. J. (2012). Additions to S&P 500 Index: Not so Informative Any More. Managerial Finance, 38, Zhang, J., Lin, E. C. and Shin, H. (2010). S&P 500 Index Inclusions and Analysts Forecast Optimism. The Journal of Investing, 19, Zhou, H. (2011) Asymmetric Changes in Stock Prices and Investor Recognition around Revisions to the S&P 500 Index. Financial Analysts Journal, 67,