University of California Davis Momentum Stock Returns Discussion
Question Description
I’m working on a economics discussion question and need an explanation and answer to help me learn.
The discuss topic is: Share your own explanation for what you think might be behind one of the effects (either momentum or a calendar effect) weve discussed in this class. Do you believe it? Do you think it tells the whole story, or is there something else going on as well?
1 attachmentsSlide 1 of 1attachment_1attachment_1.slider-slide > img { width: 100%; display: block; }
.slider-slide > img:focus { margin: auto; }
Unformatted Attachment Preview
Evidence on Short-term Momentum
?
Short-term momentum is the tendency of stocks that have recently gone up to
continue going up (in the short term)
?
Studied by Jegadeesh and Titman (1993)
? Analyzed stock price data for 1965-1989
? Studied relative strength stocks
? i.e. those whose returns exceeded the market over the previous 3-12 months
? The portfolio formed on the basis of returns realized in the past 6 months
generates an average cumulative return of 9.5% over the next 12 months but
loses more than half of this return in the following 24 months.
Jegadeesh, Narasimhan and Sheridan Titman, Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency. Journal
of Finance. 48, No. 1, 65-91.
1
De Bondt and Thaler vs. Jegadeesh and Titman
?
De Bondt and Thaler: Mean reversion
? Prior losers have the biggest subsequent gains
?
Jegadeesh and Titman: Price momentum
? Prior winners have the biggest subsequent gains
?
How can both be true?
? Jegadeesh and Titman used 3-12 month holding periods
? De Bondt and Thaler used 3-5 year holding periods
2
What drives price momentum?
?
Jegadeesh and Titmans hypothesis: Underreaction to good earnings
announcements
? Found that winner stocks outperformed loser stocks in the first few months
after the announcements
? But the initial loser stocks performed better in the 8-20 months after that
?
Why would the market behave this way?
? Positive feedback traders (à la Shleifer)
? Underreaction to short-term info and overreaction to long-term info
3
Earnings Drift
?
Ball and Brown (1968) found price drifts surrounding annual earnings reports:
? Most of the information contained in reported income is anticipated by the
market before the annual report is released. In fact, anticipation is so accurate
that the actual income number does not appear to cause any unusual jumps
in the announcement month. To illustrate, the drifts upward and downward
begin at least 12 months before the report is released
and continue for
approximately one month after. The persistence of drifts
suggests not only
that the market begins to anticipate forecast errors early in the 12 months
preceding the report, but also that it continues to do so with increasing success
throughout the year.
Ball, Ray and Phillip Brown (1968). An Empirical Evaluation of Accounting Income Numbers. Journal of Accounting Research. Vol 6, No. 2,
159-178.
4
How do we measure surprises?
?
Statistical formula for determining if an earnings announcement is a surprise:
Standardized Unexpected Earnings (SUE)
?????? ? ???????4
?????????? =
??????
?
?
?
?
?
?? = stock
?? = month
?????? = most recent quarterly earnings report for ?? in quarter ??
???????4 = quarterly earnings report from 4 quarters earlier
?????? = standard deviation of the numerator over the previous 8 quarters
Chan, Louis, Narasimhan Jegadeesh, and Josef Lakonishok (1996). Momentum Strategies. Journal of Finance. Vol. 51, No. 5, 1681-1713.
5
Implications for the EMH
?
Are price momentum and earnings momentum the same?
? Yes?
? Very bad for the EMH
? Historical price series cannot be correlated with unknown risk factor
? No?
? Not as bad for the EMH
? Earnings momentum could be due to inflation illusion (Chordia and
Shivakumar [2006] and Modigliani and Cohn [1979])
Chordia, Tarun and Lakshmanan Shivakumar (2006). Earnings and Price Momentum. Journal of Financial Economics. Vol 80, No. 3. 627-656.
Modigliani, Franco and Richard Cohn (1979). Inflation, rational valuation and the market. Financial Analyst Journal. 35, 24-44.
6
The Inflation Illusion Hypothesis
?
Inflation Illusion: Stock investors do not correctly anticipate impact of inflation on
future earnings growth
?
Consequence: Stocks with earnings growth positively correlated with inflation will
be undervalued (and vice versa)
?
Effects on drift:
? Assume market gradually corrects for mis-valuation of stocks
? Effect: Price drift
7
Is it Price Momentum or Earnings Momentum?
?
Chordia and Shivakumar method to determine if earnings momentum is the
primary driver of drift:
? Construct zero-investment portfolio (denoted PMN = positive minus negative)
? Long on stocks with high earnings surprises
? Short on stocks with negative earnings surprises
? Use SUE to measure surprises
?
Findings:
? PMN captured price momentum phenomenon time series and cross-section
? ? Earnings momentum is the primary driver of price drift
Chordia, Tarun and Lakshmanan Shivakumar (2006). Earnings and Price Momentum. Journal of Financial Economics. Vol 80, No. 3. 627-656
8
The January Effect
?
First observed by Wachtel (1942)
?
Rozeff and Kinney (1976):
? Analyzed NYSE stock prices 1904-1974
? Average monthly return in January: 3.5%
? Average monthly return in non-January months: 0.5%
? 1/3 of annual returns occurred in January
Wachtel, Sidney (1942). Certain Observations on Seasonal Movements in Stock Prices. The Journal of Business of the University of Chicago. Vol. 15, No. 2, 184-193.
Thaler, Richard (1987). Anomalies: The January Effect. Economic Perspectives. Vol. 1. No. 1, 197-201.
Rozeff, Michael and William Kinney, Jr. (1976). Capital Market Seasonality: The Case of Stock Returns. Journal of Financial Economics. 3, 379-402.
9
The January Effect and Firm Size
?
Lakonishok and Smidt (1988)
? DJIA does not exhibit abnormally high returns in January
?
Keim (1983)
? ½ of excess returns for small firms in January are in first 5 trading days
?
Reinganum (1983)
? January effects higher for small firms whose prices declined in previous years
? No excess returns for past years winners
? Suggestive of tax-loss selling explanation
Lakonishok, Josef and Seymour Smidt (1988). Are Seasonal Anomalies Real? A Ninety-Year Perspective. Review of Financial Studies. Vol. 1, No. 4, 403-405.
Keim, Donald (1983). Size Related Anomalies and Stock Return Seasonality. Journal of Financial Economics. 13-22.
Reinganum, Marc (1983). The Anomalous Stock Market Behavior of Small Firms in January: Empirical Tests for Tax-loss Selling Effects. Journal of Financial Economics. 89-104.
10
The January Effect and Tax-Loss Selling
?
Wash-sale rule: Cannot claim loss if security is repurchased in 30 days (U.S.)
?
Grinblatt and Keloharju (2004)
? Panel data study on investors in Finland
? No wash sale rule
? Investors engage in tax-loss selling at end of the year and repurchase stocks in
January
?
Gultekin and Gultekin (1983)
? Examine January effect in 16 countries
? Many have January effects larger than the U.S.
Grinblatt, Mark and Matti Keloharju (2004). Tax-Loss Trading and Wash Sales. Journal of Financial Economics. Vol. 71, No. 1, 51-76.
Gultekin, Mustafa and Bulent Gultekin (1983). Stock Market Seasonality: International Evidence. Journal of Financial Economics. 12, 469-81.
11
Is Tax-Loss Selling the whole story?
?
Kato and Schallheim (1985)
? Found January effect in Japan
? Japan had no capital gains tax (or capital losses)
?
Berges, McConnell, and Schlarbaum (1984)
? Found January effect in Canada before 1972
? Canada had no capital gains tax before 1972
?
Thaler (1987)
? Little correlation between Japanese and American stock prices ? Unlikely
foreign investors driving Japanese January effect
Kato, Kiyoshi and James Schallheim (1985). Seasonal and Size Anomalies in the Japanese Stock Market. Journal of Financial and Quantitative Analysis. Vol. 20, Issue 2, 243-260.
Berges, Angel, John McConnell, and Gary Schlarbaum (1984). The Turn-of-the-Year in Canada. Journal of Finance. Vol. 39, No. 1.
Thaler, Richard (1987). Anomalies: The January Effect. Economic Perspectives. Vol. 1. No. 1, 197-201.
12
Is it Window Dressing?
?
Window dressing: Portfolio managers rebalancing portfolios at the turn of the year
to match benchmarks
?
No reason to January effect would be limited to small stocks
13
The Other January Effect
?
Wall Street lore: January returns predict returns for the rest of the year
?
Cooper, McConnell, and Ovtchinnikov (2006)
? Studied stock returns over 1940-2003
? January returns do have predictive power for the next 11 months
? Controls include Business cycle and presidential cycle
? Effect found among:
? Large and small stocks
? Growth and value stocks
Cooper, Michael, John McConnell, and Alexei Ovtchinnikov (2006). The Other January effect. Journal of Financial Economics. Vol. 82, Issue
2, 315-341.
14
The Weekend Effect
?
Wall Street lore: Traders are reluctant to carry positions into the weekend
? Should cause price declines on the last trading day of the week
?
Fields (1931)
? Stock data 1915-1930
? Prices actually rise on Saturdays (last trading day during that time)
?
Cross (1973)
? Stock data 1953-1970
? S&P 500 index rose 62% of the time on Fridays vs. 39.5% of the time on
Mondays
? Average Friday return: 0.12%, average Monday return: -0.18%
Fields, Morris (1931). Stock Prices: A Problem in Verification. Journal of Business. 4, 415-418.
Cross, Frank (1973). The Behavior of Stock Prices on Fridays and Mondays. Financial Analysts Journal. November-December, 67-69.
15
Do people hate Mondays?
?
Rogalski (1984)
? Studied trading data from October 1, 1974 to April 30, 1984
? Comparing Monday opening prices to Monday closing prices
? Stocks actually rise on average
? Monday decline to due difference between Monday opening and Friday
closing
? Weekend returns positive during January
? Highest for smallest firms
?
Gibbons and Hess (1981)
? Treasury bill returns lower on Mondays compared to other days
Rogalski, Richard (1984). New Findings Regarding Day-of-the-Week Returns Over Trading and Non-Trading Periods: A Note. Journal of Finance, December 1984, Vol. 34, No. 5, 1603-1614.
Gibbons, Michael and Patrick Hess (1981). Day of the Week Effects and Asset Returns. Journal of Business. 54, 579-596.
16
Pre-Holiday Effects
?
Fields (1934): DJIA seems to increase unusual amounts before holidays
?
Lakonishok and Smidt (1988)
? Average returns 0.219% on day before a holiday
? Average returns 0.0094% on typical day
? 51% of total capital gains on DJIA occurred on the 10 pre-holiday days
Fields, Morris (1934). Security Prices and Stock Exchange Holidays in Relation to Short Selling. Journal of Business. 7, 328-338.
Lakonishok, Josef and Seymour Smidt (1988). Are Seasonal Anomalies Real? A Ninety-Year Perspective. Review of Financial Studies. Vol. 1, No. 4, 403-405.
17
Disappearance of Pre-holiday Effects
?
Chong, Hudson, Keasey, Littler (2005)
? Stock data 1991-1997
? Days before holidays exhibited negative returns
? Abnormal pre-holiday returns disappeared 1997-2003
? At least for the U.S.
? Pre-holiday effects declined in U.K. and Hong Kong
? But not as much as in the U.S.
?
Potential explanation: Traders anticipating the pre-holiday effects and calibrating
Chong, Ryan, Robert Hudson, Kevin Keasey, and Kevin Littler (2005). Pre-Holiday effects: International evidence on the decline and reveral of
a stock market anomaly. Journal of International Money and Finance. Vol. 24, Issue 8, 1226-1236.
18
Calendar Effects and Data Mining
?
With 5% statistical significance, then 5% of the time insignificant effects will appear
significant
?
Sullivan, Timmerman, and White (2001)
? Examined 100 years of stock price data
? Concluded:
? Calendar effects do have significant p-values
? But p-values are insignificant when considered within the universe of all
hypotheses
Sullivan, Ryan, Allan Timmerman, and Halbert White (2001). Dangers of data mining: The case of calendar effects in stock returns. Journal
of Econometrics. Vol. 105, Issue 1, 249-286.
19
Is this really just p-hacking?
?
Revisiting the chart from De Bondt
and Thaler (1985), showing returns to
winner and loser portfolios in the 60
months after their construction. The
sharp spikes in the loser portfolios are
the month of January.
?
The Sullivan, Timmerman, and White
(2001) results would have us believe
those spikes are random chance, and
their statistical significance is the
result of data mining.
De Bondt, Werner and Richard Thaler (1985). Does the Stock Market Overreact. Journal of Finance. Vol. 40, No. 3, 793-805.
20
Conclusion
?
Still dont understand cause behind many calendar effects
? Is all of it just data mining?
?
Markets evolve
? Calendar effects may come and go
? Implies they were irrational for a time
21
Purchase answer to see full
attachment
Tags:
business and finance
accounting
stock returns
Student has agreed that all tutoring, explanations, and answers provided by the tutor will be used to help in the learning process and in accordance with Studypool’s honor code & terms of service.
