Joint work with Greg J. Mecca and Brian R. Walkup

Considerable growth in passive investing and exchange-traded funds (ETFs) has raised questions about their influence on market efficiency. Index additions and deletions provide a setting for examining the price effects of demand and supply shocks associated with benchmark changes. Extending established event-study methods to S&P 500 changes going back to 1993, we investigate the relationship between ETF growth and the index inclusion effect. Consistent with prior research, we find significant abnormal returns around index changes over the full sample. However, their magnitude declines substantially over time, with deletion effects approaching zero in the most recent decade and smaller positive effects remaining for additions. Annual and quarterly regressions reveal a statistically significant association between ETF growth and the declining magnitude of abnormal returns over the longer sample periods. We also document a decline in tracking errors among S&P 500 index funds over the same period. These findings have implications for optimal index tracking, particularly the tradeoff between tracking risk and the costs of rebalancing around benchmark changes.