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Applied Financial Economics

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Anomalies in US equity markets: a re-examination of the January effect

Seyed Mehdian & Mark J. Perry Available online: 07 Oct 2010

To cite this article: Seyed Mehdian & Mark J. Perry (2002): Anomalies in US equity markets: a re-examination of the January effect, Applied Financial Economics, 12:2, 141-145 To link to this article: http://dx.doi.org/10.1080/09603100110088067

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Applied Financial Economics, 2002, 12, 141 145

Anomalies in US equity markets: a reexamination of the January eVect

S E Y E D M EH D I A N and M A R K J. P E R R Y * { School of Management and * Department of Economics, University of Michigan-Flint, Flint, Michigan 48502, USA E-mails: seyed@int.umich.edu and * mjperry@umich.edu

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This study investigates the January eVect in US equity markets using three market indexes from 19641998: Dow Jones Composite, NYSE Composite and the SP500. Chow tests for structural stability indicate that the estimated parameters in an equation testing for monthly seasonal eVects in the stock market are not stable over time. In the 19641987 sample period it is found that January returns are positive and signicant in all three stock market indexes. After 1987, January returns are positive but not statistically diVerent from zero. The results therefore provide no statistical support for the January eVect in US equity markets in the post1987 market crash period.

I. INTRODUCTION The e cient market hypothesis (EMH) posits that stocks are priced e ciently to reect all available information about the intrinsic value of the security. An e cient market is also one where all unexploited prot opportunities are eliminated by prot seeking investors. A large number of empirical studies in nance, however, have documented several persistent and exploitable seasonal patterns in equity markets, which have challenged the EMH. If stock market anomalies exist, investors can generate abnormal returns using trading rules to exploit the predictable behaviour of stock prices, an outcome that is inconsistent with the EMH. One of the best-known stock market anomalies is the January eVect (see RozeV and Kinney, 1976; Haugen and Jorion, 1996), that occurs when stock returns in January are signicantly higher than returns in other months of the year. The January eVect has generally been found: (1) to aVect small rms more than large rms and (2) to occur mostly in the early part of the month (Banz, 1981; Keim, 1983). Two hypotheses have been put forward to explain the January eVect. First, the `tax-loss selling hypothesis (Reinganum, 1983) argues that returns in January are signicantly positive for those stocks with negative returns
{ Corresponding author.

during the previous year or towards the end of the year. The hypothesis assumes that investors sell poorly performing stocks at the end of the year in order to realize capital losses for tax purposes. Investors then buy stocks after the rst of the year to re-establish their portfolios and this buying pressure creates the January eVect. However, Gultekin and Gultekin (1983) study the January eVect in 16 international stock markets with diVerent tax calendars and report that the January eVect is present in fteen of the countries studied. A second explanation for the January eVect is the `institutional investor behaviour hypothesis (see Haugen and Lakonishok, 1988). This hypothesis postulates that institutional investors, `warehouse money in a market index used to measure their performance until the end of the year, and then buy stocks after the rst of the year, which puts upward pressure on security prices and creates the January eVect. Most previous studies of the January eVect make no attempt to explicitly test for structural stability of the estimated coe cients and therefore have assumed that the data series used are intertemporally stable. This article investigates the long-term stability of the January eVect using Chow break point tests to see whether the eVect changes over time. There is a further test to nd whether

Applied Financial Economics ISSN 09603107 print/ISSN 14664305 online # 2002 Taylor & Francis Ltd http://www.tandf.co.uk/journals DOI: 10.1080 /0960310011008806 7

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this eVect occurs in the rst trading week of January or later in this month. In this paper it is documented that US equity returns in three major stock indexes (Dow Jones Composite, New York Stock Exchange and S&P 500) are not structurally stable over time and there is a signicant structural break around the 1987 stock market crash. Evidence is also found that while January stock returns are signicantly positive from 1964 to 1998, they are statistically insignicant after 1987. That is, the results reveal no signicant support for the January eVect in the post-crash era in US equity markets. In addition, it is demonstrated that stock returns are negative, though statistically insignicant, during rst ve trading days of January as opposed to the rest of the trading days in this month. This nding is inconsistent with the results previously reported in the literature (Keim, 1983). This paper is organized as follows. Section II discusses the stock market data and the methodology used. Section III presents the empirical results and Section IV contains the summary and conclusions.

S. Mehdian and M. J. Perry

III. EMPIRICAL RESULTS Equation 2 is estimated for each stock index using OLS, and the estimated coe cients with their t-statistics are reported in Table 1. As can be seen, there is a statistically signicant, positive January eVect in all three stock indexes over the 4 June 1964 to 8 August 1998 sample period (at the 1% level for the DJCOMP and at the 5% level for the NYSE and the SP500). The returns during April are also positive and signicant at the 5% level for all indexes. These results are generally consistent with the ndings previously reported in the literature, cited earlier, that mean stock returns in January are positive and signicant. As mentioned before, most previous studies of stock market anomalies do not test whether the estimated coe cients are stable over time. In this paper, a series of Chow breakpoint tests are conducted of the null hypothesis that the estimated parameters reported in Table 1 are stable over the entire sample period. Table 2, Panel A displays the F-values from Chow tests using 1 October, 1987 (a period right before the stock market crash) as the break point. The evidence indicates that the estimated parameters are structurally unstable for all indexes at the 10% level or higher. Equation 2 is then re-estimated over the postcrash period only to test for the structurally stability of the esti-

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II. DATA AND METHODOLOGY The analysis is conducted using daily closing values from three major US stock market indexes: the Dow Jones Composite (DJCOMP), the New York Stock Exchange Composite (NYSE), and the Standard & Poors 500 (SP500), from 4 June 1964 to 8 August 1998 (8301 observations). Returns for each stock index are computed as: Rit logIit =Iit1 100 1

Table 1. Regression results for January eVect: 6/4/1964 to 8/14/ 1998 DJCOMP JAN FEB MAR APR MAY JUN 0.0853 (2.60)*** 0.0275 (0.79) 0.0191 (0.60) 0.0680 (2.05)** 70.0092 (-0.28) 0.0017 (0.05) 0.0465 (1.42) 70.0012 (70.04) 70.0088 (70.26) 0.0010 (0.03) 0.0298 (0.88) 0.0489 (1.47) NYSE 0.0805 (2.52)** 0.0347 (1.03) 0.0346 (1.11) 0.0683 (2.11)** 0.0064 (0.20) 0.0180 (0.58) 0.0316 (0.99) 0.0153 (0.50) 70.0039 (70.12) 0.0027 (0.09) 0.0354 (1.06) 0.0482 (1.49) SP500 0.0780 (2.31)** 0.0317 (0.89) 0.0343 (1.05) 0.0782 (2.29)** 0.0058 (0.17) 0.0172 (0.53) 0.0359 (1.07) 0.0124 (0.38) 70.0078 (70.23) 0.0084 (0.26) 0.0344 (0.98) 0.0487 (1.43)

where Rit is the daily percentage return of stock index i on day t, and Iit and Iit1 are closing values on day t and t 1 for the same index. Monthly dummy variables (D 1 to D12 ) are created and the January eVect is tested using the following equation: Rit 1i D1 2i D2 3i D3 ; . . . ; 10i D10 11i D 11 12i D12 "t 2

JUL AUG SEP OCT NOV DEC

In Equation 2 Rit is the daily return of index i as dened earlier, D1 through D12 are dummy variables for each month of the year such that D1 1 if day t falls in January and D2 D12 0 otherwise; D 2 1 if day t is in February and D1 D3 D12 0 otherwise, and so on. The s are coe cients to be estimated, and "t is a random error term. The estimated coe cient 1i will be signicantly positive for those stock indexes that exhibit a January eVect.

Notes: T-statistics are in parentheses. *** indicates statistical signicance at the 0.01 level, ** at the 0.05 level.

Anomalies in US equity markets

mated coe cients using 1 January199 4 as the breakpoint. The F-values in panel B of this table are insignicant, providing evidence that the parameters are structurally stable in the post 1987 stock market crash period.1

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Given the results of the Chow breakpoint tests, the data set is divided into two subsample periods: the pre-1987 crash period, the post-1987 crash. Equation 2, is then reestimated for these two subsample periods and the ndings are reported in Tables 3 and 4. The evidence in Table 3 indicates that the January eVect is clearly present in the pre-crash 19641987 sample period for all three stock indexes, since returns in January are signicantly positive at the 5% level of signicance. The results presented in Table 4, on the other hand, suggest that there is no January eVect in the post-crash 19871998 period, since January returns are positive but insignicant for each stock index. In sum, while evidence is found of a January seasonal before the 1987 market crash, there is no evidence of the January eVect in the post market crash era. This means that the ndings do not support either the `tax loss-selling hypothesis or `institutional investor behaviour hypothesis in US equity markets after the 1987 stock market crash. Finally, following Keim (1983), an investigation is conducted to see whether the January eVect occurs in the rst ve trading days of January. To accomplish this, one must rst decompose the mean returns in January into two com-

Table 2. Tests of intertemporal stability A. 6/4/1964 to 8/14/1998 NASDAQ NYSE SP500 (Break point: 10/1/1987) 2.07** 1.77** 1.66*

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B. 11/1/1987 to 8/14/1998 DJCOMP NYSE SP500 (Break point: 1/1/1994) Notes: ** indicates statistical signicance at the 0.05 level and * at the 0.10 level. F-statistics are based on the null hypothesis that the slope coe cients and the overall regressions are structurally stable over the sample period, against the alternative hypothesis that they are not stable. 0.68 0.72 0.72

Table 3. Regression Results for the January eVect: 6/4/1964 to 10/ 01/1987 DJCOMP JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 0.0887 (2.39)** 70.0118 (70.30) 0.0227 (0.63) 0.0472 (1.26) 70.0487 (71.31) 0.0022 (0.06) 0.0185 (0.50) 0.0328 (0.93) 70.0158 (70.42) 0.0492 (1.37) 0.0327 (0.84) 0.0177 (0.47) NYSE 0.0865 (2.34)** 70.0019 (70.05) 0.0420 (1.17) 0.0587 (1.57) 70.0449 (71.22) 0.0222 (0.62) 0.0010 (0.03) 0.0465 (1.33) 70.0177 (70.48) 0.0554 (1.55) 0.0431 (1.12) 0.0106 (0.28) SP500 0.0796 (2.09)** 70.0045 (70.11) 0.0448 (1.21) 0.0656 (1.70)* 70.0487 (71.29) 0.0194 (0.53) 0.0011 (0.03) 0.0469 (1.30) 70.0216 (70.56) 0.0583 (1.59) 0.0383 (0.96) 0.0132 (0.34)

Table 4. Regression results for Januar y eVect: 11/01/1987 to 8/14/ 1998 DJCOMP JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC 0.0780 (1.41) 0.1098 (1.87)* 0.0117 (0.22) 0.1117 (1.99)** 0.0737 (1.33) 0.0004 (0.01) 0.1065 (1.91)* 70.0770 (71.42) 0.0078 (0.13) 0.0274 (0.49) 0.0241 (0.43) 0.1132 (2.04)** NYSE 0.0680 (1.32) 0.1115 (2.05)** 0.0192 (0.39) 0.0885 (1.70)* 0.1145 (2.22)** 0.0090 (0.18) 0.0971 (1.88)* 70.0542 (71.08) 0.0291 (0.53) 0.0169 (0.33) 0.0198 (0.38) 0.1258 (2.43)** SP500 0.0744 (1.31) 0.1079 (1.79)* 0.0129 (0.24) 0.1049 (1.82)* 0.1201 (2.12)** 0.0125 (0.23) 0.1104 (1.94)* 70.0648 (71.17) 0.0249 (0.41) 0.0275 (0.48) 0.0266 (0.46) 0.1219 (2.14)**

Notes: T-statistics are in parentheses. *** indicates statistical signicance at the 0.01 level, ** at the 0.05 level and * at the 0.01 level.
1

Notes: T-statistics are in parentheses. *** indicates statistical signicance at the 0.01 level, ** at the 0.05 level and * at the 0.01 level.

These results are not sensitive to the exact breakpoint chosen. Although not reported here, six other breakpoint dates also resulted in insignicant F-values.

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ponents: (a) the mean return for the rst ve trading days of the month (rst trading week) and (b) the mean return for the last 25 trading days of the month (second to fth trading weeks). Then, diVerence-of-mean s tests are conducted based on the null hypothesis that the mean returns during the rst trading week of January are equal to the mean returns during the rest of January. Table 5 provides means, standard deviations, and tvalues from the diVerence-of-means tests for the entire sample (19641998) and the two sub-sample periods. As can be seen in Panels A and B, mean returns during the rst trading week of January are higher than the returns during the rest of the month, but the diVerence-of-means tests show that this diVerence is not statistically signicant. Additionally, Panel C shows that in the postcrash period, the mean returns for the rst trading week of January are actually negative, and are not signicantly diVerent from

S. Mehdian and M. J. Perry

the rest of the month. Consequently, the ndings reveal no signicant support for the results reported previously in the literature that the January eVect substantially occurs in the rst ve trading days of January.

I V . SU M M A R Y A N D C O N C LU S I O N This study re-examines the January eVect in US equity markets from 19641998 using three major market indexes (DJCOMP, NYSE, and SP500). Over the full sample period, it is found that a signicantly positive January eVect exists in all three stock market indexes consistent with previous literature on stock market anomalies. However, it is documented that the estimated parameters in equations testing for monthly seasonal eVects are not structurally stable over the full sample period and there is a statistically signicant intertemporal break around the time of the 1987 stock market crash. The January eVect is then examined separately in the precrash period and postcrash periods. In the precrash period, evidence of the January eVect is found in each of the three stock market indexes. In the postcrash period, however, January returns are found to be positive but statistically insignicant, indicating that the January eVect does not exist in the postcrash period. Consequently, the results do not provide any statistical support for either the `tax-loss selling or `institutional investor behaviour eVects in the US stock market after 1987. Furthermore, in contrast to the previous literature, this paper shows that stock returns during the rst week of January are not statistically diVerent from the returns during the rest of the month. The ndings, in general, indicate that the January eVect can no longer be considered one of the several well-documented seasonal anomalies in the US stock market. Since seasonal anomalies represent unexploited prot opportunities and violate market e ciency, the disappearance of the January eVect may imply that US stock markets are gradually becoming more `weakly e cient in the postcrash period. The absence of a January eVect in the post crash era may be due to the signicant growth in the derivative markets for equities and increased trading by institutional investors who process information faster and at lower transaction costs (Kamara, 1997). REFERENCES
Banz, R. W. (1981) The relationship between return and market value of common stock, Journal of Financial Economics, 9, 3 18. Gultekin, M. and Bulent Gultekin, N. (1983) Stock market seasonality: international evidence, Journal of Financial Economics, 12, 46981. Haugen, R. A. and Jorion, P. (1996) The January eVect: still there after all these years, Financial Analysts Journal, 52, 2731.

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Table 5. January returns by week of the month Week 1 A. 6/4/648/14/98 DJCOMP Mean Standard dev. NYSE Mean Standard dev. SP500 Mean Standard dev. Observations B. 6/4/6410/1/87 DJCOMP Mean Standard dev. NYSE Mean Standard dev. SP500 Mean Standard dev. Observations C. 11/1/878/14/98 DJCOMP Mean Standard dev. NYSE Mean Standard dev. SP500 Mean Standard dev. Observations Weeks 2-5 DiVerence of means test

0.1733 1.0599 0.1083 1.0501 0.0777 1.1252 84

0.0730 0.8157 0.0766 0.7810 0.0779 0.8247 606

0.08 0.27 0.01

0.2500 0.8542 0.2130 0.8432 0.1866 0.8612 59

0.0654 0.7911 0.0682 0.7751 0.0642 0.7981 409

1.55 1.24 1.02

70.0076 1.4390 70.1387 1.4150 70.1790 1.5770 25

0.0889 0.8665 0.0942 0.7950 0.1065 0.8787 197

70.32 70.80 70.75

Notes: T-statistics are based on the null hypothesis that mean returns during the rst trading week of the month is equal to mean returns during the rest of the month.

Anomalies in US equity markets

Haugen, R. and LaKonishok, J. (1988) The Incredible January EVect (Homewood, IL: Dow Jones Irwin). Kamara, A. (1997) New evidence on the Monday seasonal in stock returns, Journal of Business, 70, 6384. Keim, D. B. (1983) Size-related anomalies and stock return seasonality: further empirical evidence, Journal of Financial Economics, 12, 1332.

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Reinganum, M. R. (1983) The anomalous stock market behavior of small rms in January: empirical tests for tax-loss selling eVects, Journal of Financial Economics, 12, 89 104 RozeV, M. and Kinney, W. (1976) Capital market seasonality: the case of stock returns, Journal of Financial Economics, 3, 379 402.

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