The Influence of Tax-Loss Selling by Individual Investors in Explaining the January Effect
Journal article by Ken Johnston, Don R. Cox; Quarterly Journal of Business and Economics, Vol. 35, 1996
Journal Article Excerpt
The influence of tax-loss selling by individual investors in explaining the January effect. by Ken Johnston , Don R. Cox INTRODUCTION Large abnormal returns for stocks in the month of January have been documented and examined by numerous researchers. These returns generally are shown to occur primarily for small firms and accrue mostly during the first five days of January.(1) Despite considerable attention, the cause of this phenomenon remains unresolved. This study provides a unique test of Ritter's (1988) tax-loss selling explanation of the January effect. Ritter proposes that abnormal returns in January are the result of the buying and selling behavior of individual investors who concentrate their investments in smaller firms. Near the end of each year individuals increase their selling of securities that have declined in value in order to realize tax losses. Reinvestment of funds early in the following year pushes up stock prices. Ritter's hypothesis assumes that individual and institutional investors concentrate in different stocks, that short-term buying and selling pressures affect stock prices, and that most individuals, seeing a direct tax benefit from selling of stocks that have incurred capital losses, have a stronger incentive to sell than many institutional investors who are largely unmotivated by such tax incentives. Consistent with his hypothesis, Ritter finds that there is a seasonal pattern in the turn-of-the-year buy/sell ratio of individual investors. Using a database of daily purchases and sales of New York Stock Exchange stocks by cash account customers of Merrill Lynch, he finds a below normal buy/sell ratio in late December and an above normal ratio in early January. Several additional studi... |
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