January Effect Examination
Introduction
We chose to examine and test the January Effect as a trading strategy. The January Effect is well documented in the literature since Rozeff and Kinney (RK) 1976. Their study showed share returns appear to be abnormally high in January in the United States. In Australia, Brown et al (BKKM) 1983 demonstrated that ASX share returns peak in January and July. This trend appears to persist over time and markets across the world so it could be an exploitable trading strategy, taking advantage of market inefficiency. If this Effect exists the lowest risk trading strategy would be to buy the portfolio in late December to take advantage of the lowest prices and sell the portfolio in January when prices are rising.
Through this research report we aim to determine if the January Effect is in fact a profitable trading strategy and whether the size of the firm influences the profitability of the strategy. The trading strategy will be investigated through the analysis of the Australian stock market, specifically through the following index portfolios: ASX All Ordinaries, S&P/ASX 20, S&P/ASX MIDCAP 50, and ASX Small Ordinaries.
Literature Review
Wachtel (1942) was the first to document seasonality in the Dow Jones Industrial Average from 1927 to 1942. He showed rising returns from December to January in eleven of fifteen years studied. Rozeff & Kinney (1976) found statistically significant differences in mean returns for months on the US stock market. Jones & Wilson (1989) tested the January Effect on seven assets from 1871 to 1986 and found strong seasonality in returns in US markets.
Officer (1975) and Brown, Keim, Kleidon & Marsh (1983) (BKKM) showed the January Effect with a premium of up to 5.06% in Australian markets. Brailsford & Easton (1993) (BE) investigated monthly equity return seasonality from 1958 to the mid-1980s to extend the Australian evidence on seasonality and showed that returns in January and July are consistently higher
We chose to examine and test the January Effect as a trading strategy. The January Effect is well documented in the literature since Rozeff and Kinney (RK) 1976. Their study showed share returns appear to be abnormally high in January in the United States. In Australia, Brown et al (BKKM) 1983 demonstrated that ASX share returns peak in January and July. This trend appears to persist over time and markets across the world so it could be an exploitable trading strategy, taking advantage of market inefficiency. If this Effect exists the lowest risk trading strategy would be to buy the portfolio in late December to take advantage of the lowest prices and sell the portfolio in January when prices are rising.
Through this research report we aim to determine if the January Effect is in fact a profitable trading strategy and whether the size of the firm influences the profitability of the strategy. The trading strategy will be investigated through the analysis of the Australian stock market, specifically through the following index portfolios: ASX All Ordinaries, S&P/ASX 20, S&P/ASX MIDCAP 50, and ASX Small Ordinaries.
Literature Review
Wachtel (1942) was the first to document seasonality in the Dow Jones Industrial Average from 1927 to 1942. He showed rising returns from December to January in eleven of fifteen years studied. Rozeff & Kinney (1976) found statistically significant differences in mean returns for months on the US stock market. Jones & Wilson (1989) tested the January Effect on seven assets from 1871 to 1986 and found strong seasonality in returns in US markets.
Officer (1975) and Brown, Keim, Kleidon & Marsh (1983) (BKKM) showed the January Effect with a premium of up to 5.06% in Australian markets. Brailsford & Easton (1993) (BE) investigated monthly equity return seasonality from 1958 to the mid-1980s to extend the Australian evidence on seasonality and showed that returns in January and July are consistently higher
References: Banz, R. 1981, ‘The Relationship Between Return and Market Value of Common Stock’, Journal of Financial Economics, pp 3-18 Beedles, W., Dodd, P Brailsford, T.J. 1993, ‘Seasonality and Institutional Factors in the New Zealand Equity Market’, Pacific Accounting Review, December, vol. 5, pp 1 -26 Brailsford, T, Heaney, R & Bilson, C Brailsford, T.J. & Easton, S.A. 1991, ‘Seasonality in Australian Share Price Indices Between 1936 and 1957, Accounting and Finance, November, vol 31, pp 69-85 Brown, P., Keim Gultekin, M. N. & Gultekin, N. B., 1983, ‘Stock Market Seasonality: International Evidence’, Journal of Financial Economics, vol 12, pp 469-81 Rozeff, M Van Dijk, M.A. 2007 The Size Effect Paradox, RSM Eramus University 2007