Week 8 - Week 8: Anomalies, Violations of Market Efficiency...

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Week 8: Anomalies, Violations of Market Efficiency Paul Dou
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Department of Accounting and Finance Slide 2 Violation of weak form market efficiency Calendar effect Contrarian Momentum Violation of semi-strong form market efficiency Post-Earnings-Announcement-Drift (PEAD) Value effect Size effect Issues associated with assessing market efficiency Objectives and learning outcomes from this module
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Department of Accounting and Finance Slide 3 January effect (Keim (1983) JFE): January Effect—average stock’s return in January is more than 5 times the mean monthly return > A large part of the typical stock’s annual return is generated during January – Can yield net trading profits after deducting transaction costs » Buy stocks before Christmas and sell at the end of January This finding seems robust when checked in many countries around the world. The January effect is known for several decades, but the phenomenon continue although we know about it. Violation of Weak-Form Market Efficiency
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Department of Accounting and Finance Slide 4 Violation of Weak-Form Market Efficiency
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Department of Accounting and Finance Slide 5 Monthly Average Returns from Stock Markets Around the World for January and the Other Monthly Average Returns from Stock Markets Around the World for January and the Other 11 Months 11 Months
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The most common explanation for the January effect is a “taxation” explanation. The “taxation” explanation for the January effect - an example: assume that in 2008 Dan had labour income of $80,000. He also had income from investments as provided by the following table: Violation of Weak-Form Market Efficiency Stock Investment Value on 31.12.2008 1 $10,000 $22,000 2 $20,000 $8,000 3 $10,000 $15,000 4 $15,000 $18,000 total $55,000 $63,000
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Assume now that the tax on all sorts of income is 25% . If Dan does not sell any of his securities, he will pay taxes only on his labour income. His tax payment will be as follows Labour income $80,000 Tax (25%) $20,000 Violation of Weak-Form Market Efficiency
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A tax saving strategy: sell stock number 2 before the end of the year. The tax payment is as follows: Instead of paying $20,000, Dan paid only $17,000, implying a tax saving of $ 3,000 . Labour income $80,000 Loss from investments $-12,000 Income before tax $68,000 Tax (25%) $17,000 Violation of Weak-Form Market Efficiency
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Department of Accounting and Finance Slide 9 Why do stock prices jump in January? Assume that an investor sells the stock of a losing firm for tax purposes , but he believes that the stock is a good long-run investment. In January he buys the stock again. The tax saving strategy is applicable only with stocks that experienced big losses recently. Another explanation of January effect: “window dressing” from institutional investors January effect most pronounced for small firms! Neglected firms and liquidity premium ?
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Week 8 - Week 8: Anomalies, Violations of Market Efficiency...

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