The Indexer's Dilemma - Rational choices and irrational volatility

Sammanfattning

This paper examines whether institutional fund flows, driven by index inclusion, affects stock volatility and performance in the Swedish equity market - with an S&P 500 sample serving as a comparative benchmark. Using a mediation analysis framework on two panel datasets covering 2016 to 2025, we find no evidence of ownership-related index effects in the Swedish market. This suggests that the findings of prior US-based literature may not be directly transferable to markets dominated by mutual funds rather than ETFs, where the arbitrage mechanism of the latter may play a crucial role in transmitting such effects. We do, however, observe volatility enhancing index effects in the Swedish market through alternative channels. Thus, we are unable to rule out that ownership effects do exist in the Swedish market but go undetected due to noise in our institutional ownership proxy variable. Due to the endogeneity issues inherent to index construction, causal inference regarding return effects is not possible in either market, although we do observe a relative underperformance of indexed stocks - possibly attributable to hindsight bias, differences in dividend policy or index bubble mechanics. Whilst index-related return effects require no immediate action from the passive investor, the volatility findings do give cause for attention as OMXS30 stocks appear to carry genuinely higher price variation at both at the individual stock and portfolio level.