Demand Curves for Stocks Do Slope Down: New Evidence from an Index Weights Adjustment

Abstract

Weights in the Toronto Stock Exchange 300 index are determined by the market values of the included stocks' public f loats. In November 1996, the exchange implemented a previously announced revision of its definition of the public f loat. This revision, which increased the f loats and the index weights of 31 stocks, conveyed no information and had no effect on the legal duties of shareholders. Affected stocks experienced statistically significant excess returns of 2.3 percent during the event week, and no price reversal occurred as trading volume returned to normal levels. These findings support downward sloping demand curves for stocks.An obvious event with which to examine the slope of demand curves for stocks is one that changes supply. In the absence of new information, a shift in supply should not affect stock prices if demand curves for stocks are f lat. Scholes~1972!, using a sample of secondary equity distributions, asks whether stocks are "unique works of art" or merely abstract claims to residual cash f lows with many close substitutes, as is assumed in much of finance theory. Scholes finds that the negative price impact of secondary offerings depends on the seller's identity-implying the revelation of unfavorable informationand rules out a pure supply effect. Mikkelson and Partch~1985!, also using a sample of registered and unregistered secondary offerings, find weak evidence of downward sloping demand curves, but are unable to cleanly distinguish this explanation from the alternative explanation based on unfavorable information.A different class of events-additions to widely followed stock market indexes-ostensibly provides a setting where information effects should not be present. Shleifer~1986! documents a permanent price increase for stocks * All authors are at the University of Alberta. We thank René Stulz~the editor!, Harry Turtle, and seminar participants at the University of Alberta, the EFMA, the EFA, and the NFA meetings for helpful comments. We are especially grateful to an anonymous referee for many insightful suggestions. We also thank Lou Hollinger for clarifying several legal issues, James McVicar and Paul D'Souza of the Ontario Securities Commission for answering queries about filing requirements, Lori Bak of Benefits Canada for providing statistics on indexing in Canada, John Kaszel of IFIC for providing index fund information, and William MacKenzie for providing ownership data for non-TSE firms. We retain responsibility for any remaining errors. Aditya Kaul acknowledges financial support from the Pearson fellowship at

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“…Therefore, no issues relating to the time 4 For related evidence on low returns for stocks with high idiosyncratic volatility relative to the Fama and French (1993) model, see Ang et al (2006). 5 See Shleifer (1986), Kaul, Mehrotra, and Morck (2000), and Hegde and McDermott (2003). 6 Time-series studies on block purchases and sales of stocks, as well as the trades of institutional investors, have consistently uncovered evidence of temporary price pressure on individual securities conditional upon unusual demand (Lakonishok, Shleifer, andVishny 1991, 1992;Lakonishok 1993, 1995).…”

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“…An important consideration for event studies, and particularly those with long event windows, is the choice of benchmark against which abnormal returns are estimated (Lyon, Barber, & Tsai, 1999: 165). Different benchmarks have been used in other studies, for example a standard market model (Kaul, Mehrotra, & Morck, 2000;Chen, Noronha, & Singal, 2004;Shankar & Miller, 2006) and a capital asset pricing model (CAPM) (Amihud & Mendelson, 1986;Elliot, Van Ness, Walker, & Wan, 2006;Shankar & Miller, 2006). These benchmarks have been shown to be inadequate -the CAPM, in particular, fails to account for expected returns on the basis of company size, as well as growth versus value (Fama & French, 1992;1993;1996;1998) and resource versus non-resource shares -which is relevant especially in the South African context (Van Rensburg 2001;Van Rensburg & Robertson 2003a, 2003b.…”