Index-tracking rigidity and arbitrage opportunities in MSCI index reconstitutions

Xin Chang, Jiang Luo, Jiaxin Peng, Shuoge Qian and Choon Wee Tan

Pacific-Basin Finance Journal, 2025, vol. 93, issue C

Abstract: Using the reconstitution of MSCI indices in 56 markets worldwide from 2006 to 2023, we discover arbitrage opportunities arising from index-tracking investors' rigidity to minimize tracking errors around the dates when index reconstitution changes become effective (i.e., effective dates). We document pronounced abnormal returns and trading volume on the last trading day before the effective date. Arbitrageurs can exploit this predictable pattern of stock price changes and earn sizable abnormal returns if they long the added and short the deleted stocks on the announcement date and close their positions at the end of the day before the effective date. Additional analysis reveals how index-tracking investors and arbitragers interact to shape stock prices and equity-lending activities around MSCI index reconstitutions.

Keywords: Index reconstitution; Index-tracking investors; Tracking errors; Arbitrageurs; Security lending (search for similar items in EconPapers)
JEL-codes: G10 G11 G14 G23 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:pacfin:v:93:y:2025:i:c:s0927538x25002379

DOI: 10.1016/j.pacfin.2025.102900

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