FE Notes 20 Asset Pricing Anomalies and the CAPMF.doc

Financial Economics Notes 20 Asset Pricing Anomalies and the CAPM Calendar Anomalies (Seasonality in Stock Returns) (For references see Sharpe et al. chapter 16) Weekend Effect French (1980): Monday Returns are significantly lower than on other days The January Effect (End of the Year Effect) Rozeff and Kinney (1976): Returns higher in January (end of the USA tax year). In the UK there is both a January Effect and a similar effect in April (the end of the UK tax year). The Monthly Effect (End of the Month Effect) Ariel (1987): Returns higher in the first half of month. Lakonishok and Smidt (1988): Higher returns in the first three trading days of the month plus the last trading day of the previous month Holiday Effect Ariel (1990): Returns higher on the two trading days preceding public holidays Intraday Effect Harris (1986): Returns highest over the last two trades of the day. The Size Effect Banz(1981): average returns found to be higher for small firms. Keim (1983): most of the small firm effect occurs in January. These are called ‘anomalies’ because they are not predicted: they apparently violate the CAPM. Note that they do not always persist. For example, size effect reversals have occasionally observed. Anomalies may not indicate market inefficiency, because rational economic explanations may exist. Furthermore, it may not be possible to exploit the anomalies for gain (because of transactions costs). CAPM Anomalies: The Size Effect and Other Anomalies 1. Banz (1981) used the ‘two-pass’ methodology of Black, Jensen and Scholes (1972) and Fama and MacBeth (1973). First pass: prior estimates of asset betas were made using the market model with 5 years of monthly returns data. Assets were grouped into portfolios and the portfolio betas were re-estimated using 60 further months of data. Second pass: the portfolio betas were used in 12 monthly cross-sectional regressions of the form (1) Here is the average market value of stocks in portfolio i in month t