Market Anomalies: A Review of Literature and Empirical Evidence

Market anomalies are empirical findings that contradict established theories of asset-pricing behavior. While such anomalies often provide profit opportunities, they can also reveal inadequacies in risk models that underpin them.

Once identified by researchers, these anomalies often fade or decrease as investors attempt to profitably exploit them without endangering their financial well-being. But can this happen without creating additional imbalances within themselves?

The January Effect

The January Effect, wherein stock prices tend to be higher in January than other months of the year, has become one of the most celebrated market anomalies since its discovery in 1976. Since its discovery, researchers have attempted to explain this anomaly. One popular theory suggests tax-loss harvesting, in which investors sell loss-making stocks in December in order to offset capital gains taxes and thus lower tax bills prior to rebound buying in January; another explanation might involve “window dressing,” where professional fund managers adjust mutual fund portfolios so as to increase returns in January – both may increase returns exponentially!

Persistence of this anomaly indicates that other factors must also be at work; its decline for both large and small firm indices as well as disappearance for Russell Indices suggests additional causes are at work. Therefore, in this paper we investigate its evolution using daily and monthly data.

The Weekend Effect

There is a wealth of literature demonstrating a weekend effect in stocks, specifically lower returns on Mondays relative to Fridays. Unfortunately, the cause remains elusive and various theories have been proposed for its explanation, including specialist-related explanations [2, measurement error due to bid-ask bounce measurement error delay trade settlement or non-synchronous trading.

Popular belief holds that the weekend effect dissipates over time due to investor adaptation (Lo, 2004; Schwert 2003; Urquhart & McGroarty 2016), yet recent studies indicate it persists in some markets – Latin American included.

This paper explores the hypothesis that Monday returns aren’t suffering as a result of weekend effects; rather they’re connected with small-cap firms’ tendency to invest more volatile stocks during weekdays than other firms do – this explains why returns were weaker on Monday. By using CRSP equal-weighted daily stock returns and firm size dummy variables as evidence against this claim. Specifically, our results support that smaller firms tend to invest more volatile stocks during weekdays – an explanation which helps explain the weaker return seen on Monday.

The Reversal Anomaly

This paper summarizes existing contributions that document various anomalies and their causes, as well as any discrepancies with classical theories in that documented anomalies have a temporal component which makes them hard to account for within the static asset pricing paradigm.

Research on the Reversal Anomaly has demonstrated that return reversals are more prevalent among winners than losers, especially high turnover stocks purchased by institutions and boasting strong liquidity characteristics. This is particularly evident among stocks with high turnover that tend to display strong liquidity characteristics.

Reversal anomaly-based trading strategies can generate positive contrarian profits; however, their returns depend on many variables, including investor sentiment, market dynamics and trading strategies; they are even affected by market size; therefore it must be adjusted appropriately in order to take these factors into account.

The Small-Cap Effect

The small-cap effect is an intriguing phenomenon that suggests smaller firms outperform their larger counterparts, due to factors including mispricing, unmeasured risk, constraints to arbitrage and selection bias.

Rolf Banz, Eugene Fama and Kenneth French’s seminal work on this market anomaly was published during the 1980s and 90s by academics such as Rolf Banz, Eugene Fama and Kenneth French – their research led to specialized small-cap funds as well as changing investment mandates of pension funds, endowments and other large pools of capital.

Studies have demonstrated that the small-cap effect tends to outshone large caps following business cycle peaks and underperform in the year preceding cycle troughs, as term structure risk has also been found associated with this premium. Linear models do not account for its cyclical behavior.