Academic journal article Journal of Financial Management & Analysis

Testing Calendar Effect on Nigerian Stock Market Returns : Methodological Approach

Academic journal article Journal of Financial Management & Analysis

Testing Calendar Effect on Nigerian Stock Market Returns : Methodological Approach

Article excerpt


Calendar effects have remained an area of growing interest for researchers in the last three decades as the presence of the phenomena has been evidenced even in the most developed capital markets of the world (Ali and Akbar1). The effects of these security price anomalies have been regarded as strong evidence against efficient market hypothesis in the field of finance and economics. Anomalies which are significant deviations from market efficiency have been reported in a number of countries, including U.K., U.S.A., Canada, Japan, Finland and Australia (French2; Jaffe and Westerfield3; Board and Sutclifle4; Connoly5; Solnik and Bousquet6 ; Barone Connolly7; Agrawal and Tandon8).

In the traditional finance framework where agents are assumed to be "rational" and where there are no financial market frictions, a security's price equals its "fundamental value". This is the discounted sum of expected future cash flows, where in forming expectations, investors correctly process all available information, and where the discount rate is consistent with a normatively acceptable preference specification. The hypothesis that actual prices reflect fundamental values is the Efficient Markets Hypothesis (EMH). Put simply, under this hypothesis, "prices are right", in that they are set by agents who understand Bayes law and have sensible preferences. In an efficient market, there is "no free lunch" as no investment strategy can earn excess riskadjusted average returns, or average returns greater than are warranted for its risk (Barberis and Thaler9). Rationality here means two things. First, when they receive new information, agents (investors) update their beliefs correctly in the manner described by Bayes Law. Second, given their beliefs, agents make choices that are normatively acceptable, in the sense that they are consistent with savage's notion of Subjective Expected Utility (SEU).

For instance, the idea of weak-form-efficiency requires that there are no consistent patterns in the stock prices and consequently returns. While early tests of random walk did not detect any strong evidence of the existence of any return pattern, more recent studies have demonstrated market inefficiency by identifying systematic variations in stock returns. Some of the more important systematic variations or anomalies as they are often referred to are value line's investment recommendations, the small firm effect and extraordinary returns related to the time of calendar effect. Such systematic changes, variations or patterns in stock returns are referred to as the monthly effect, the weekly effect, the daily effects or broadly categorized as calendar effects (Radcliffe10). The existence of seasonality or variations in domestic and international markets suggests market inefficiency in that investors should be able to earn abnormal rates of returns incommensurate with the degree of risk that they are exposed to.


However, a review of the empirical literature on calendar effect reveals that the most important calendar anomalies studied are the day of the week effect (significantly different returns on some day of the week, usually higher Friday returns and lower Monday returns), the month of the year effect (relatively higher January returns), the trading month effect (returns higher over the first forth night of the month and the holiday effect (returns higher on the day before vacations).

Day of the week and monthly effect patterns in returns (if they do exist) might enable investors to take advantage of relatively regular shifts in the market by designing trading strategies which can take advantage of such predictable patterns. Because of transaction cost, those trading strategies may not be able to generate the much desired profits, but they still may provide illuminating insights to investors. For a rational financial decision maker, returns constitute only one side of the decision making process. The other aspect that must be taken into account when one makes investment decisions is risk or volatility of returns. …

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