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
MARKET REACTION TO THE NASDAQ Q-50 INDEX
A Project
by
Yi-Chi Huang
Approved by:
__________________________________, Committee Chair
Eric C. Lin
____________________________
Date
ii
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
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
TABLE OF CONTENTS
Chapter
1. INTRODUCTION ........................................................................................................ 1
2. LITERATURE REVIEW ............................................................................................. 2
Investor Awareness and the Price Response ........................................................... 2
Reveal of Information ............................................................................................. 3
3. BACKGROUND OF THE STUDY ............................................................................. 4
4. HYPOTHESES............................................................................................................. 6
5. METHODOLOGY RECOMMENDATION ................................................................ 7
6. DISCUSSION............................................................................................................... 8
Appendix A ...................................................................................................................... 9
References ...................................................................................................................... 12
v
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.
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 2000. The
events like implementation of Regulation FD, adoption of decimalization and
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.
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.
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.
audit opinion that is currently withdrawn;
5.
ed" 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
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
× Divisor before Adjustments
Market Value before Adjustments
The NASDAQ Q-50 Index began on October 10, 2007 at a base value of 150.00.
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 NASDAQ100 Index intra-quarter without being a constituent of the NASDAQ Q-50 Index at the
time of addition to the NASDAQ-100 Index.
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:

H01: The trading volume and price of stocks do not react to the addition
event to NASDAQ Q-50 Index.

H02: The inclusion announcements of addition to NASDAQ Q-50 Index are
information-free events.
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
Firm Size
×
NASDAQ Q-50 Index Market Cap 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.
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.
9
Appendix A
Table A1: Eligibility of being ranked in the NASDAQ Q-50 Index. (The criteria are
retrieved from www.nasdaq.com.)
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);

-financial company;

issuer currently in bankruptcy
proceedings;

200,000 shares;

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.;


agreement or other arrangement which would likely result in the
security no longer being Index eligible;
10

with an audit opinion that is currently withdrawn;

e "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

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:

Market (unless the security was dually listed on another U.S. market
prior to January 1, 2004 and has continuously maintained such
listing);

-financial company;

proceedings;

200,000 shares (measured annually during the ranking review
11
process);

ized 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);

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

with an audit opinion that is currently withdraw
12
References
Baran, L., & King, T. D. (2012). Cost of Equity and S&P 500 Index Revisions. Financial
Management, 41, 457-481.
Cai, J. (2007). What’s in the News? Information Content of S&P 500 Additions.
Financial Management, 36, 113-124.
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, 1901-1930.
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, 1821-1840.
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, 380-402.
Zhang, J., Lin, E. C. and Shin, H. (2010). S&P 500 Index Inclusions and Analysts’
Forecast Optimism. The Journal of Investing, 19, 50-57.
Zhou, H. (2011) Asymmetric Changes in Stock Prices and Investor Recognition around
Revisions to the S&P 500 Index. Financial Analysts Journal, 67, 72-84.