This study examines the abnormal returns, trading activity and long term performance of stocks that were added to the S&P 500 Index during the period 1990 to 2002. By using a three-factor pricing model that allows for firm size and value characteristics as well as market risk, we are able to shed new light on the widely observed index effect. We argue that for the years 1990-1997 in particular, firm size mattered in the long-run and firm size effects cannot be captured by a single factor model for abnormal returns. We also find a transitory increase in trading volume between the announcement and a few days after the effective date. The seal of S&P 500 Index membership has very long term effects and inclusion is not an information-free event.

Keywords: Index effect, S&P 500, market efficiency, price pressure, three-factor model

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