Friday and January Effect on the Stock Market - Research Paper Example

Friday and January effect on the stock market Literature review: A number of researches and studies have been conducted to examine the impact of Friday and January effects on the stock returns in the regional and global stock exchanges. The objective of this part of the study is to review the available literature and present a comprehensive report on the results of the previous researches and the influence of those results in the conduct of the current research. The aim of the study is to examine through the study of the literature the month effect on the stock index returns and thereby to conclude the date on which the stock returns tend to be at higher levels. By conducting relevant studies on daily stock returns data of Dow Jones Industrial Average (DJIA) for the past ninety years Lakonishok and Smidt (1988) report on the patterns occurred in the US stock markets. This study concentrated on testing the real constant seasonal patterns of the US markets and concluded that almost 75% of the data for the period of 90 years showed a positive impact on the rate of stock returns during the second half of the month of December. The authors are confident in claiming that the second half of the month of December exhibits an extraordinary performance with respect to the stock returns in US stock exchanges. However Thaler (1987) has a different opinion to offer. According to him there has been no positive impact of the stock returns in the DJIA during the second half of the month of December and therefore there can be no higher returns during the month of January from the DJIA index. He argues that DJIA index consists of the stock values of only larger firms and in order to find the real January effect it is necessary to consider the stock returns in respect of smaller firms only where the returns would be able to exhibit greater weight than their market value as consisted in the index. However Thaler (1987) comments that about one-third of the annual returns have occurred during the month of January alone perhaps in respect of the stocks of smaller firms. The study of Marrett and Worthington’s (2006) found that considerably higher stock returns occur in January only with respect to small cap and retail firms. By empirical data the authors proved that the results of previous studies with respect to monthly seasonality can be considered only in so far these two classes of shares are concerned. Wang and Koutianoudis (n.d.) reiterate that during the month of January the investors are able to make larger gains in their dealings in stocks. The reason behind their analogy is that such returns are possible due to the behaviour of the markets during January which is the month to acquire back the securities disposed off during the month of December when there is likely to be a decline in the market indicator. This strategy is usually described as ‘bed-and-breakfasting’. Alternatively the strategy is also called as ‘buy-and-hold’. Therefore, there is strength in the argument that January effect could be regarded as an investment strategy that will result in profits to the investors. Wang and Koutianoudis (n.d.) further observed that the stock returns during the month of January are found to be larger than that of other months and it happens only when the markets face stable and upward periods. On the other hand when the market traverses through downward period, the January effect seems to take an opposite direction. At that point of time the stock returns are significantly lower than most of the other months of the year. Kim and Park (1994) observed during the periods of later half of December and first half of the month of January the stock markets are experiencing mostly a holiday effect in the United States. Researchers have found that the mean values of the stock returns during the pre-holiday periods in all the three major US stock markets were much higher than all other days of the year. Studies have proved that the January effect really takes off during the last day of December. They also have suggested a strong impact of firm size on the holiday effect. In 1990, Ogden has postulated a ‘turn of month’ hypothesis. According to this theory the United States stock returns enjoy a surge around the turn of each calendar month. This surge turns out to be significant in December being the end of the year and this phenomenon might be caused by the reason of the standardization in the payment system as is being practiced in the country. The main reason for such happening may be found in the availability of surplus cash at the turn of the month especially at the end of the year in the hands of the investors. By reason of this there is a natural increase in the demand for stocks. There are empirical studies that go to prove there are differing patterns in the stock returns of the daily markets that take place during different days of the week. Keim and Stambaugh (1984) are of the view that last trading day of the week enables the investors to make significantly higher returns and this aspect has been proved using empirical data gathered. They further state that the returns are significantly larger during any last trading day even if the last trading day is not a Friday. Keim and Stambaugh (1984) also contend that the stock markers behave to provide abnormally low returns on a Monday. This gives rise to the point that there exists a negative correlation between the returns on Friday and the stock returns on Monday as well as other days of the week. Mookerjee and Yu (1999) through the study conducted on the stock returns of Shanghai and Shenzhen securities exchanges on the basis of daily price indices for the years 1990 AND 1991 have proved that both Shanghai and Shenzhen enables higher stock returns during Thursdays rather than on Fridays. Jaffe and Westerfield (1985) offer a different view in that they state the Japanese market provides a lower average returns on Thursdays. However, normally the Japanese common stocks should act to provide higher than anticipated returns on Thursdays since the securities processing is being undertaken in the third working day of the week. In the Indian stock market context Das and Arora studied the day-of-the-week effects in NSE stock returns in the year 2007. The study was undertaken to examine the impact of the day of week effect in Indian stock markets. The study also was extended to consider the impact of this effect in three different phases of market. The study covered (i) Consolidation Phase, (ii) Bearish Phase and (iii) Bullish Phase. The study reported no significant Monday or Friday effect on the stock returns except that there were found some seasonality effects. The study also proved positive stock returns to take place in Wednesdays and negative ones on Tuesdays. In respect of the effect on the different phases during Consolidation Phase 48 out of 66 stocks reported significant positive returns on Wednesday. But the study could not establish any variations in the mean values of stock returns for the Bullish and Bearish phases which imply that during these two phases marked tend to behave in a most efficient way due to some reason or other. According to Kamara (1997) the pricing system in any stock market should be based in the information efficiency of the financial markets operating in the economy. However by empirical studies it has been proved that a number of different patterns evolve on the stock prices which are independent of the informational efficiency of the financial markets. The daily effect on the stock returns in one of such patterns in the stock return movements. Elango and AlMacki (n.d.) have arrived at a conclusion that Mondays and Fridays are found to be providing lowest returns while Wednesdays are found to enable greater returns across most of the indices. Read More