Cash Balances and the January Effect in Stock Returns
Journal article by Dan W. French, Teresa D. Trapani; Quarterly Journal of Business and Economics, Vol. 33, 1994
Journal Article Excerpt
Cash balances and the January effect in stock returns. by Dan W. French , Teresa D. Trapani INTRODUCTION Rozeff and Kinney's (1976) finding that mean stock returns in January are higher than for other months has stimulated further research on January returns. These subsequent studies attribute this January effect to the concentration of high January returns in the issues of smaller companies (Banz, 1981; Keim, 1983; Blume and Stambaugh, 1983; and Ritter and Chopra, 1989). Roll (1983), observing that most of the high returns occur during the first few days in January, calls this phenomenon the turn-of-the-year effect. Of the various explanations for the turn-of-the-year effect, the tax-loss selling hypothesis (Reinganum, 1983; and Roll, 1983) in conjunction with Ritter's (1988) parking-the-proceeds hypothesis appear to be the most promising. The tax-loss selling hypothesis provides a plausible justification for investor selling behavior at year end, stating that investors sell stocks in order to realize the losses for tax purposes. The parking-the-proceeds hypothesis states that the buying and selling behavior of individual investors causes the turn-of-the-year effect. The parking-the-proceeds hypothesis theorizes that as the end of December approaches, investors tend to sell securities but not reinvest the entire proceeds immediately. Over year's end, the investors park the proceeds in anticipation of reinvesting the funds from December's sales during the month of January. The tendency of individual investors to concentrate their purchases in stocks of smaller companies produces relatively more buying pressure on the smaller stocks and hence their rise in price. Ritter identifies the tax-loss selling hypothesis as the reason that investors sell near the end of the year. The tax-loss selling hypothesis states that investors sell securities in which they have capital losses at the end of the year to realize the losses and reduce income taxes. The tax-loss selling hypothesis does provide a plausible reason to explain end-of-the-year selling, but it is not a necessary part of the parking-the-proceeds hypothesis. The more general parking-the-proceeds hypothesis need only state that investors sell near the end of the year. Ritter identifies three conditions as necessary for the parking-the-proceeds hypothesis to operate: * Individual investors' portfolios are more concentrated in low priced, low capitalization stocks than are the portfolios of institutional investors; * Buying and selling pressure affects stock prices, especially prices of smaller firms; and * Investors do not reinvest the proceeds from December's tax-motivated security sales immediately. Individual investors are net buyers of small stocks early in January using the proceeds from December's sales. Using a proprietary database of the daily purchases and sales of New York Stock Exchange stocks by cash account customers of Merrill Lynch, Pierce, Fenner, and Smith, Ritter provides empirical support for the parking-the-proceeds hypothesis. He finds buy/sell ratios for the latter part of December are significantly lower than during the early part of January. In addition, January's buy/sell ratios are significantly positively related to January small firm market returns. Dyl and Maberly (1991) provide additional support for the hypothesis. They examine odd-lot sales and purchase ratios over the turn of the year and find that odd-lot sales are relatively higher at year's end than in January, odd-lot purchases are relatively higher at the beginning of the year than in December, and both of these changes are significantly related to January market returns. Dyl and Maberly also investigate selling near the end of the year and conclude that sales are extraordinarily large at years' ends, but tax-loss selling only accentuates the level of sales; it is not the principal cause of higher January returns. Both the Ritter and Dyl and Maberly studies measure parked proceeds indirectly by inferring cash parking from individual investor buying and selling behavior. Although this is consistent with the parking-the-proceeds hypothesis, it does not represent direct evidence that proceeds are parked over year's end. It is possible that sales proceeds in December are used for other transactions, such as the substantial increase in retail activity at the end of the year as in the scenario of Ogden (1990). Ogden argues that an increase in the receipt of liquid funds at the end of the year or beginning of the new year contributes to the turn-of-the-year effect. The origins of these funds, such as private business profits or year-end bonuses, could be sources of parked proceeds.The purpose of this paper is to investigate the relationship between year-end parked cash balances and January returns to provide a direct test of the parking-the-proceeds hypothesis. To accomplish this, we collect cash balances in accounts where proceeds would ... |
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