Turn‐of‐Month Evaluations of Liquid Profits and Stock Returns: A Common Explanation for the Monthly and January Effects

Abstract

This paper presents and tests a hypothesis that the standardization of payments in the United States at the turn of each calendar month generally induces a surge in stock returns at the turn of each calendar month. The hypothesis also asserts that returns generally will be greater following the month of December and will vary inversely with the stringency of monetary policy. Empirical results using stock index returns for 1969-1986 support the hypothesis. This analysis provides an explanation for the previously documented monthly effect in stock returns and a partial explanation for the January effect.IN A RECENT PAPER, Ariel (1987) documents an important empirical regularity in stock returns and terms it the "monthly effect." Using value-weighted and equally weighted daily stock index returns for the period 1963-1981, Ariel shows that virtually all of the cumulative return on these indexes is realized on ten consecutive trading days of the calendar month, beginning with the last trading day of the month and extending through the first nine trading days of the following month. Ariel considers various explanations for this phenomenon, "but none sufficed to explain the observed empirical regularity" (p. 174). More recently, Lakonishok and Smidt (1988) examine returns on the Dow Jones Industrial Average index for the period 1897-1986 and find that significant mean daily returns are realized consistently on only four consecutive trading days of the calendar month, beginning with the last trading day of the month. These trading days will henceforth be referred to as the turn-of-month trading days.Ariel's and Lakonishok and Smidt's tests indicate that the monthly effect is not merely another manifestation of the previously documented "January effect." Rozeff and Kinney (1976) first documented that average stock index returns in January are higher than in any other month. Keim (1983) and others find that the surge in January returns is largely confined to stocks of small firms and to the first few trading days in January. Branch (1977) and others have suggested that the surge in January returns is due to year-end tax-loss selling and subsequent repurchases in January. Studies by Roll (1983), Reinganum (1983), Ritter (1988), and others provide evidence consistent with the tax-loss selling * School of Management, State University of New York at Buffalo. I am grateful to participants in the finance workshops at Arizona State University and SUNY-Buffalo, especially Richard Smith, an anonymous referee, and editor Rene Stulz for helpful comments on earlier drafts of this paper. Any remaining errors are, of course, my responsibility. 1259 1260 The Journal of Finance hypothesis. In contrast, Constantinides (1984) argues that year-end tax-loss selling cannot explain the January effect, and the empirical results of Pettengill (1986), Chan (1986), and Jones, Pearce, and Wilson (1987) are inconsistent with the tax-loss selling hypothesis.'This paper presents and tests a hypothesis that the monthly and January effects are due, at le...

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Tax Calendar Effects in the Municipal Bond Market: Tax‐Loss Selling and Cherry Picking by Investors and Market Timing by Fund Managers

“…We also obtain the monthly Standard & Poor's 500 (S&P 500) returns from Datastream. Ogden (1990) uses the spread between one-month Treasury (T)-bill rates and Federal funds rate as a measurement for monetary stringency. The conventional wisdom is that a stringent/loose monetary policy negatively/positively affects security returns.…”

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