Explanations for the January Effect

A number of explanations have been advanced for the January effect,
but few hold up to serious scrutiny.

• Tax loss selling by investors at the end of the year on stocks which have
'lost money' to capture the capital gain, driving prices down, presumably
below true value, in December, and a buying back of the same stocks in
January, resulting in the high returns.Since wash sales rules would prevent
an investor from selling and buying back the same stock within 45 days,
there has to be some substitution among the stocks. Thus investor 1 sells
stock A and investor 2 sells stock B, but when it comes time to buy back
the stock, investor 1 buys stock B and investor 2 buys stock A.

• A second rationale is that the January effect is related to institutional
trading behavior around the turn of the years. It has been noted, for
instance, that ratio of buys to sells for institutions drops significantly
below average in the days before the turn of the year and picks to above
average in the months that follow.

The Size Effect in January

Institutional Buying/Selling around Year-end

Returns in January vs Other Months- Major
Financial Markets

The Weekend Effect

The weekend effect is another phenomenon that has persisted over
long periods and over a number of international markets. It refers to
the differences in returns between Mondays and other days of the week.

Over the years, returns on Mondays have been consistently lower than
returns on other days of the week.

Prof. Aswath Damodaran