UC Berkeley

In the first chapter titled “Identifying the Effect of Stock Indexing: Impetus or Impediment to Arbitrage and Price Discovery?”, with Panos N. Patatoukas, we validate Russell reconstitution as a quasi-natural experimental setting and explore securities lending market dynamics and price discovery process at both the upper and lower cutoffs.

The rise of stock indexing has raised concerns that index investing impedes arbitrage and degrades price discovery. This paper uses Russell’s reconstitution to identify the causal effect of index investing on information arbitrage and price discovery. While index investing has no discernible effect on the ability of arbitrageurs to trade and impound news into the prices of large- and mid-cap stocks, we find that index investing increases the speed of price adjustment to news for micro-cap stocks. Our causal evidence identifies the relaxation of arbitrage constraints as a mechanism through which indexing facilitates informed trading for more arbitrage-constrained micro-cap stocks.

In the second chapter titled “Does Index Membership Affect the Quality of Mandatory Financial Report? Evidence from Index Deletions”, I examine the effect of stock indexing on mandatory disclosure quality.

This paper examines whether stock indexing affects the quality of mandatory financial reports. Using a fuzzy regression discontinuity design at the lower cutoff of the Russell 2000 Index, I find that small-cap firms moving out of the Russell 2000 exhibit more errors in annual and quarterly financial statement numbers, reduce the amount of textual disclosure, and increase the ambiguous tone in 10-K filings. On the contrary, mandatory reporting quality does not change following the addition to the Russell 2000. The evidence suggests that index deletion poses a higher informational risk to investors and highlights the positive effect of index membership in ensuring disclosure quality for small-cap firms in a limited information environment.