Abstract
Combining market data with a publicly available monthly snapshot of Deutsche Borse's index ranking list, I create a model that predicts index changes in the DAX, MDAX, SDAX, and TecDAX from 2010 to 2019 before they are officially announced. Even though I empirically show that index changes are predictable, they still earn sizeable post-announcement one-day abnormal returns up to 1.42% and -1.54% for promotions and demotions, respectively. While abnormal returns are larger in smaller stocks, I find no evidence that they are related to funding constraints or additional risk for trading on wrong predictions. A trading strategy that trades according to my model yields an annualized sharpe ratio of 0.83 while being invested for just four days a year.
Highlights
One related but unsettled research question is the existence of the index effect, i.e., abnormal returns of additions and deletions around index rebalancings
The performance is much better in the DAX (71% and 16%) and MDAX (63% and 19%) than in the SDAX (30% and 40%)
There is no benchmark for my model in the literature. It seems to predict at least the larger index changes reasonably well and empirically establishes that index changes can be predicted before their announcement
Summary
Index-linked or the so-called passive investments are growing steadily every year.1 One related but unsettled research question is the existence of the index effect, i.e., abnormal returns of additions and deletions around index rebalancings. I examine index changes within the German DAX family, i.e., the DAX, MDAX, SDAX, and TecDAX, from 2010 to 2019 with respect to their ex-ante predictability and abnormal returns around their announcement.
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