Despite the introduction of sophisticated stock market indices, investors often trade portfolios of the flawed indices to change their exposure to the market. In this study, we show that these transactions cause significant mispricing in individual stocks, especially during periods of significant market movement. As an influential, albeit flawed, stock index, we focus on the Nikkei 225. We find index constituents that are excessively weighted on the index, experience buying (selling) pressure when the stock market surges (falls), and experience price corrections after such periods of change. In contrast, non-constituent stocks do not experience such trading pressure.
Stock market index Price-weighted index Trading pressure Stock mispricing
G14 G17 G23
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Many thanks to an anonymous referee, the editor, Johnnie Johnson, Kotaro Inoue, and Seichiro Iwasawa for their comments on a draft.
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