In this article, Biktimirov examines the link between the demand for stocks and the prices of these stocks. The aim is to determine whether the demand curves for stocks are flat or whether they slope downward. A flat demand curve means that the price of stocks will not be influenced by the demand for these stocks, whereas a downward sloping demand curve indicates that a fall in demand will cause the price of the stock to fall.

Many studies have addressed the question of the demand curve form, but, according to Biktimirov, they have not made it possible to draw clear conclusions. Most of the studies were based on stock index inclusion, or deletion, which does not make it possible to separate the effect of the demand for stocks from other effects, including the information effect of index inclusion. In addition, studies found different results, depending on whether they deal with small or large caps. Studies based on small cap indexes suggest that the change in stock values is temporary (Biktimirov, Cowan, and Jordan, 2004; Shankar and Miller 2006), whereas studies based on large cap indexes conclude in a permanent increase in stock values (Wurgler and Zhuravskaya 2002; Denis et al. 2003).

In the present article, the author examines the question using the modification of the weighting of S&P indexes from cap-weighting to free-float weighting, which occurs in 2005. This event offers the advantage of not involving stock addition to—or deletion from—an index, but only a modification of the weights of the stocks, an approach which differs from those of previous studies. The present study is based on three indices, the S&P 500, S&P MidCap 400, and S&P SmallCap 600, to cover all capitalisation sizes. The free-float adjustment was accomplished in two steps, with a distance of six months between them. The stock price behaviour was analysed the day after the second step adjustment.

The author uses the Fama-French (1993) three-factor model to identify abnormal returns after the event day. In order to test the robustness of his results, he also uses a one-factor model, as well as different proxies for the market return. The conclusions were the same in all cases. It appears that a decrease in demand produces a stock price decline. This decline was permanent for the S&P 500, which is consistent with a downward sloping demand curve. For the other two indices, on the contrary, this decline was only transitory, which is consistent with a flat long-term demand for stocks. These results are consistent with the evidence presented in earlier studies.

The post-event trading volume was also analysed using the same methodology as Campbell and Wasley (1996). Biktimirov finds a significant abnormal trading volume associated with the abnormal returns.

The results suggest that the post-event behaviour of stock prices is related to firm size. The author performs further investigations using cross-sectional regressions to analyse the influence on the results of various factors. The results provide evidence that the slope of the demand curve for stocks was related not to stock capitalisation but to the degree of either systematic (beta) or total (variance) risk. Low risk is related to a permanent fall in stock value, which supports downward sloping curves. On the contrary, the transitory stock price reaction is observed for stocks with high risk, which supports the flat demand curve.

References

Biktimirov, E. N., A. R. Cowan, and B. D. Jordan, “Do Demand Curves for Small Stocks Slope Down?” Journal of Financial Research, vol. 27, 2004, p. 161-178.

Campbell, C. J., and C. E. Wasley, “Measuring Abnormal Trading Volume for Samples of NYSE/ASE and NASDAQ Securities Using Parametric and Nonparametric Test Statistics”, Review of Quantitative Finance and Accounting, vol. 6, 1996, p. 300-326.

Denis, D. K, J. J. McConnell, A. V. Ovtchinnikov, and Y. Yu, “S&P 500 Index Additions and Earnings Expectations”, Journal of Finance, vol. 58, 2003, p. 1821-1840.

Fama, E. F. and K. R. French, “Common Risk Factors in the Returns on Stocks and Bonds”, Journal of Financial Economics, vol. 33, 1993, p. 3-56.

Shankar, S. G., and J. Miller, “Market Reactions to Changes in the S&P SmallCap 600 Index”, The Financial Review, vol. 41, 2006, p. 339-360.

Wurglern J. and E. V. Zhuravskaya, “Does Arbitrage Flatten Demand Curves for Stocks?” Journal of Business, vol. 75, 2002, p. 583-608.