New evidence on the impact of tax-loss selling on the turn of the year effect

Journal

of Banking

and Finance

17 (1993)

131~144. North-Holland

New evidence on the impact of tax-loss selling on the turn of the year effect Timothy

Received

J. Brailsford

March

and Stephen

1992, final version

received

A. Easton”

May 1992

The turn of the year effect is an empirical regularity which refers to the observation that equity returns on days around the turn of the calendar year are significantly high. A common explanation for the effect is the tax-loss selling hypothesis. Three studies have tested this hypothesis by examining equity returns before and after the introduction of the War Revenue Act of 1917. However, these studies have reached inconsistent conclusions. Following these inconsistent findings. this paper examines whether the previous findings are robust to the extension of the pre-tax period, or whether the previous findings are robust to the use of daily data. In contrast to the evidence from existing research which has used daily data, a significant turn of the year effect is found prior to 1917. Furthermore, this effect is shown to be independent of other empirical regularities such as the turn of the month effect and the holiday effect, and seasonality in dividend payments cannot explain the finding. Thus, we conclude that the tax-loss selling hypothesis cannot offer a complete explanation of the turn of the year effect.

I. Introduction

A number of studies have found that the high returns observed in January are largely attributable to the first few trading days of the calendar year [Keim (1983), Reinganum (1983), among others]. Roll (1983) has also reported significantly high returns on the last trading day of the calendar year. These high returns on days around the turn of the year have been referred to as the ‘turn of the year effect’. The tax-loss selling hypothesis is generally accepted as one of the dominant explanations of this empirical regularity. The hypothesis proposes that there is downward pressure at the tax year-end on stocks that have experienced recent price declines as investors attempt to sell these stocks in order to realise the capital loss. If the Correspondence to: T.J. Brailsford, Department of Accounting and Finance, Monash University, Clayton, Melbourne, Victoria 3168, Australia *Both authors are from the Department of Accounting and Finance at Monash University, Clayton, Australia. We gratefully acknowledge the comments of Philip Brown, the anonymous referees, seminar participants at the London School of Economics, Macquarie University, Monash University, the Royal Melbourne Institute of Technology, the Universities of Adelaide. Lancaster, Queensland and Strathclyde, and delegates at the 1991 Accounting Association of Australia and New Zealand Conference. 037%4266/93,%06.00

\(_‘ 1993-Elsevier

Science Publishers

B.V. All rights reserved

loss is not realised before the tax year-end then the investor must wait until the following tax year-end before receiving the cash-flow benefit associated with the tax deductibility of the capital loss. After the tax year-end has passed, the price pressure is removed and high returns are subsequently observed as prices rebound to equilibrium levels.’ Three studies have tested the tax-loss selling hypothesis by examining equity returns before and after the introduction of the War Revenue Act of 1917.2.3 Schultz (1985) examined daily returns over the period 1900 to 1929 and found that a turn of the year effect existed only after the introduction of the Act. This result showed clear support for the hypothesis. However, Pettengill (1986) and Jones et al. (1987) using monthly Cowles Commission data, extended the study period to cover 1871 to 1938. In the period 1871 to 1917, Pettengill and Jones et al. found evidence of significantly high returns in January. This result is inconsistent with both Schultz’s findings and the predictions of the tax-loss selling hypothesis. Following these inconsistent findings, this paper examines whether the Schultz finding is robust to the extension of the pre-tax period, or whether the finding of Pettengill and Jones et al. is robust to the use of daily data. This study extends Schultz’s sample period by examining daily equity returns on the Dow Jones Railroad Index over a 28-year pre-tax period compared to his l&year pre-tax period. In contrast to Schultz’s findings, evidence of a significant turn of the year effect is found over this extended period. Furthermore, this regularity is found to be independent of the turn of the month effect and the holiday effect, and it remains after incorporating dividends into the analysis.4 While evidence suggesting an increase in the magnitude of the turn of the year effect after 1917 is also found, the results

‘As Constantinides (19X4) has shown. optimal tax trading should produce a turn of the year effect only if investors behave irrationally. Other explanations of the turn of the year effect have been offered by Ritter (198X), Rock (1988) and Keim (19X9), among others. A summary can be found in Haugen and Lakonishok (1988). ‘Marginal tax rates were increased significantly by the War Revenue Act of lYl7. Prior to the Act the maximum income tax rate was 15”,,, and this was increased to 67”,, by the 1917 Act. Similarly, the minimum income tax rate rose from one percent to 6ve percent. Indeed, prior to 1916. losses were not even deductible. See Schultz (1985). “The tax-loss selling hypothesis has been subject to a range of other empirical tests. Studies by Branch (1977), Givoly and Ovadia (1983). Reinganum (1983). and Roll (19X3) identilied Individual stocks whtch had experienced recent price declines and examined their subsequent performance. Studies by Brown et al. (19X3), and Gultekin and Gultekin (1983) examined equity returns in countries which have a non-December tax year-end. Another methodology involves examining returns before and after the introduction of taxes in a specific country. Studies such as Berges et al. (1984) and Tinic et al. (19X7) examined the impact of the introduction of the capital gains tax in Canada. The results from this range of tests have in general provided inconclusive evidence with respect to the tax-loss selling hypothesis. ‘As Schultz’s (1985) study preceded the studies by Ariel (1987.1990) and Lakonishok and Smidt (1988) on the turn of the month and holiday effects, his analysis necessarily did not examine the interdependence between these effects and the turn of the year effect.

Eoston.

suggest that the tax-loss explanation of the effect.

selling

Turn

hypothesis

of the yrur does

LfiYY

not

offer

133

a complete

2. Data and methodology The primary data set used in this study is the daily Dow Jones Railroad Index for the entire period of its computation. The composition of this equally-weighted index is as follows. From 23 September 1889 to 25 October 1896 the Index comprised 18 railroad stocks and 2 industrial stocks. From 26 October 1896 to 31 December 1969 it comprised 20 railroad stocks. The Railroad Index was used in this study rather than the Dow Jones Industrial Average which is the more frequently used index in this area of research. The advantage of the Railroad Index is that it provides a study period of 28 years prior to the introduction of the War Revenue Act of 1917, whereas the Industrial Average which was first calculated in 1896 only provides a comparable study period of 21 years.” Over the period 1896 to 1917, the Railroad Index comprised relatively larger companies than the Industrial Average. Using calendar year-end price to proxy for size, the mean and median size of stocks in the Railroad Index, respectively, exceed the mean and median size of stocks in the Industrial Average in all but two years. Thus, as the turn of the year effect is negatively associated with firm size, our analysis is biased uguinst finding a turn of the year effect. Furthermore, the Railroad Index is available on a daily basis, whereas the Cowles Commission data only provides a series of monthly index values. As previous evidence has shown, the turn of the year effect is predominantly centred around the first few trading days of the calendar year, and therefore a daily index series is required for this analysis. The War Revenue Act of 1917 was introduced in October 1917 and therefore Schultz (1985) and Jones et al. (1987) identified the 1917/18 turn of the year as the earliest period during which a tax trading effect was likely to be observed. Similarly, our pre-tax period is defined as the period concluding on the penultimate trading day of 1917, and the post-tax period is defined as the period commencing on the last trading day of 1917. The post-tax period is further divided into two subperiods of equal duration. The first subperiod is defined as the period concluding on the penultimate trading day of 1943, and the second subperiod is defined as the period from the last trading day of 1943 to the penultimate trading day of 1969. Previous studies have used a number of definitions of the turn of the year 5The Railroad Index comparison with the October 1916, at which expanded to 30 stocks. Pierce ( 1986).

was replaced in 1970 by the Dow Jones Transportation Index. By way of Railroad Index, the Industrial Average consisted of 12 stocks until 4 time the list was expanded to 20 stocks. On I October 1928, the list was Since then. the number of stocks in the Index has remained constant. See

134

T.J. Bra&ford and S.A. Easton, Turn of the year effecf

period to examine the turn of the year effect. Keim (1983) examined returns over the first live trading days of the year, while Roll (1983) examined returns over the first fourteen trading days of the year and the last trading day of the previous year. Schultz defined the return over the turn of the year period as the nine-day return from the last trading day in December through to the eighth trading day in January. Our study uses three definitions of the return over the turn of the year period. These are the seven-day return from the last trading day in December through to the sixth trading day in January, the nine-day return from the last trading day in December through to the eighth trading day in January, and the eleven-day return from the last trading day in December through to the tenth trading day in January.h Returns are also calculated for corresponding non turn of the year periods, that is, any seven, nine and eleven trading day period which does not overlap the respective turn of the year period. Similarly, returns are also calculated for each seven, nine and eleven-day period surrounding each turn of the month (excluding the turn of the year). Further, returns are also calculated for each seven-, nine- and eleven-day period surrounding a holiday which does not overlap with a turn of the year period. This allows comparisons to be performed between turn of the year returns and non turn of the year returns, between turn of the year returns and turn of the month returns, and between turn of the year returns and holiday period returns. For non-normal distributions, the power of non-parametric tests is much greater than the power of standard parametric tests and this is especially true when one or both samples contain outliers. As these characteristics may be present in the data, the MannWhitney test was used to test for differences in returns. As the Railroad Index is a price index, it is possible that seasonality in dividend payments could induce seasonality in observed rates of return. Thus, if a turn of the year effect is found, and it is found to be independent of the other empirical regularities, then a dividend explanation must be examined. A two-stage procedure is used to test for the impact of dividends. First, a dividend yield series was constructed using prices surrounding exdividend dates. These prices were collected for each stock in the Railroad Index over the period 31 December 1896 to 29 December 1917. An implied dividend yield series was constructed because actual dividend yields were unavailable. Prices were collected from the New York Tribune from 31 December 1896 to 31 July 1915, and from the Chicago Tribune from 1 August 1915 to 29 December 1917. Prices were collected from 31 December 1896 rather than from 23 September 1889, which is the first date the Index ‘Lakonishok and Smidt (1984, 1988) and Keim (1989) found some evidence of large price increases over the last live trading days of the year. In this study, additional analyses were also performed with these days included in the turn of the year period. When these days were included, the signilicance of the turn of the year returns increased in both the pre- and post-tax periods.

TJ. Brailsford and S.A. Easton, Turn of the year efect

135

was calculated, as the composition of the Railroad Index is available only from 7 October 1896. Hence, direct adjustment to the returns is not possible’. Each dividend yield is calculated as the change in price from the closing price on the last cum-dividend trading day to the opening price on the exdividend day divided by the closing price on the last cum-dividend day.8 The dividend yield series is then converted into a series of average annualised dividend yields. Average annualised dividend yields for each turn of the year period are calculated as follows. The dividend yields are summed across both stocks and years. This total is then divided by the number of years in the pre-tax period to provide the average dividend yield on the Index per year. This figure is then compounded into an annual yield.’ The same procedure is used to calculate average annualised dividend yields for the non turn of the year periods, for the turn of the month periods, and for the holiday periods. The second step of this test is to compute confidence intervals for the Mann-Whitney tests for differences in returns. The Mann-Whitney confidence interval is obtained by first calculating k, which is given by k = wziz test statistic, c( n(n + 1)/2, where w,,~ is the 42 quantile of the Mann-Whitney is the desired significance level and n is the sample size. The kth smallest and kth largest differences from all possible pairs between the two samples are then determined, which represent the lower and upper bounds, respectively, of the confidence interval [see Noether (1967) and Conover (1980)]. The lower bound of the confidence interval provides the difference in returns between the two samples that may be tolerated, while still allowing the null hypothesis to be rejected. If the difference in dividend yields between the two samples exceeds this lower bound, then it is no longer possible to reject the null hypothesis that there is no difference in returns (capita1 gain and dividends) between the two samples. ‘An analysis of ex-dividend day behaviour of all NYSE listed stocks shows that the percentage of ex-dividend days falling over the turn of the year period was greater in the period 23 September 1889 to 30 December 1896 than in the period 31 December 1896 to 29 December 1917. Further, the relative magnitude of the percentage change in stock price on the ex-dividend day over the turn of the year period was larger in the earlier period. Data collected from the New York Tribune show that NYSE listed stocks went ex-dividend on 854 occasions over the earlier period of which 5.50% fell during the turn of the year period, and went ex-dividend on 5849 occasions over the latter period of which 4.70% fell during the turn of the year period. The mean percentage change in price on the ex-dividend day for all NYSE listed stocks over the earlier period was 1.98”/, over the turn of the year period compared to 1.57% over the non turn of the year period, while over the latter period, the respective percentages are 1.16% compared to 1.42%. ‘The use of percentage change in price to proxy for dividend yield is consistent with Barclay (1987) who found that over the period 1900 to 1910, the prices of NYSE stocks fell on exdividend days, on average, by the full amount of the dividend. ‘Annualised yields were computed, rather than seven-, nine- and eleven-day yields, to aid readability.

3. Results 3.1.

TWX of‘ the IYJNI’effkt

Table 1 presents the mean return and the percentage of days on which a positive return was observed over the seven-day, nine-day and eleven-day turn of the year periods.” Comparable figures for the seven-day, nine-day and eleven-day returns for the non turn of the year periods,” and the Mann-Whitney test statistics for differences in the ranks of returns are also presented. From table 1, a significant turn of the year effect is evident in the sevenday and eleven-day turn of the year returns over the pre-tax period using the non-parametric sign test. The effect is not evident in the nine-day turn of the year returns, while the returns over the remainder of the year are in fact negative. Using the Mann-Whitney test to examine differences in the ranks of returns, the difference between the turn of the year returns and returns over the remainder of the year is significantly different from zero at the 0.05 level for the seven-day and eleven-day turn of the year periods (M=2.13 and M = 2.16, respectively).” These results indicate that a turn of the year effect existed prior to the introduction of the War Revenue Act of 1917 and therefore appear to reject the tax-loss selling hypothesis as a complete explanation of the effect. In contrast. Schultz (1985) could not reject the hypothesis. There is strong evidence that the strength of the turn of the year effect increases in the posttax period. A significant turn of the year effect is evident for the seven-day, nine-day and eleven-day turn of the year returns in the post-tax period. The Mann-Whitney test statistics for the post-tax period are 5.02, 5.02, and 4.33, respectively. The results for the two post-tax subperiods are also significant for the three definitions of the turn of the year. This evidence is consistent “‘All scvcn-day. nine-day and eleven-day turn of the year returns were less than three standard deviations from the mean. Furthermore. only two of the 56 two-day returns calculated over days +7 and +X. and days +9 and + IO were more than two standard deviations from their respective means. Both of these returns were positive and occurred over the period covering days + 7 and + 8. and la) 2.12 and 2.09 standard deviations from the mean return. “The seven-day returns for the non turn of the year periods were computed as nonoverlapping returns. Any seven-day period which impinged on Ihe seven-day turn of the year period was excluded from the analysis. The resulta reported in table 1 are based on seven-day periods constructed using the first trading day following the turn of the year period as the inilial start day. Seven-day periods were also constructed by rolling forward the initial start day by one trading day at a time until a repetitive sample of returns was obtained. The results using these alternative seven-day returns were virtually idenkxl to those reported here. The same procedure was used and similar results w’ere obtained for the nine-day and eleven-day periods. “Differences between turn of the year returns and returns over the remainder of the year were also examined by regressing the return series on a constant and a zero-one dummy variable which was set to unity for turn of the year returns and zero otherwise. The adjusted f-statistics on rhe dummy variable coefiicienl. computed using Whlk’s (19X0) procedure, were 2.72, I.95 and These tindings arc 7.72 for the seven-day, nine-day and eleven-day returns. respecllvely. consistent with the more powerful non-parametric results.

77. Bruils/ford and S.A.

Table Mean

turn

Mann-Whitney

test statistic

for differences

IYIX~I969 Mean turn of year return (‘I,,) Percentage positive Sample size Mean non turn of year return (‘I,,) Percentage positive Sample size Whitney

test statistic

for differences

l9lHm I943 Mean turn of year return (‘I,,) Percentage positive Sample size Mean non turn of year return (“J Percentage posttive Sample size Mann-Whitney

test statistic

for differences

I944~/969 Mean turn of year return (“J Percentage positive Sample size Mean non turn of year return Percentage positive Sample size Mann-Whitney

137

I

of the year returns, mean non turn of the year returns and tests for differences between turn of the year and non turn of the year returns.

Mean turn of year return (I’,,) Percentage positive Sample size Mean non turn of year return (“J” Percentage positive Sample size

Mann

Turn qf the year effect

Easton.

test statistic

(“,,)”

for differences

Days -1 to +6

Days -I to +x

0.7 I 71.4* 28 -0.02 50.7 1157

60.7 28 - 0.02 51.4 889

2.13* 2.35 7n.9** 52 - 0.03 52.7* 200X 5.02** 2.57 73.1* 26 PO.15 50.9 1073 3.45** 2.13 84.6** 26 0.12 54.9** 935 3.69**

0.68

1.38 2.70 80.8** 52 PO.08 53.4*+ I546 5.02** 3.1 I X0.8** 26 PO.28 52.1 826 3.67** 2.28 80X** 26 0.15 55.0** 720 3.41**

Days -1 to +10 I.13 71.4* 28 - 0.04 51.6 721 2.16* 2.25 73.1** 52 PO.09 51.9 1245 4.33** 2.79 73.1* 26 PO.32 49.9 670 3.06** 2.31 73.1* 26 0. I7 54.3* 575 3.12**

*Signiticant at the 0.05 level (two-tailed test). **Significant at the 0.01 level (two-tailed test). “Based on non turn of the year return periods commencing the trading day after the turn of the year period. Similar results were obtained using non turn of the year return periods commencing 2,3....,7 trading days after the seven-day turn of the year period, commencing 2,3,...,9 trading days after the nine-day turn of the year period, and commencing 2,3,...,1 I trading days after the eleven-day turn of the year period. Returns were excluded if they impinged on the turn of the year period, or on the market closures of 1914 (World War I) and 1933 (banking moratorium).

138

TJ. BrailsJiwd

and S.A. Easton,

Turn of the yeur &m

with the findings of both Schultz (1985) and Jones et al. (1987) in the post-tax period. It may be argued that the strength of the turn of the year effect in the post-tax period reflects tax-loss selling. However, the existence of a turn of the year effect prior to the introduction of the War Revenue Act of 1917 suggests that the tax-loss selling hypothesis can only provide a partial explanation of the effect. A similar conclusion was reached by Tinic et al. (1987) with respect to the introduction of the capital gains tax in Canada.

3.2. Other empirical

regularities

The tax-loss selling hypothesis can only be rejected as a complete explanation of the turn of the year effect if the effect is found to exist prior to the introduction of the War Revenue Act of 1917, and if the effect is found to be independent of other empirical regularities. Such regularities include the turn of the month effect [Ariel (1987) and Lakonishok and Smidt (1988) among others] and the holiday effect [Lakonishok and Smidt (1988) and Ariel (1990) among others]. This section of the paper examines the independence between the turn of the year effect and these other regularities.’ 3 In order to test for the independence between the turn of the year effect and the turn of the month effect, three definitions of the return over the turn of the month were employed, with each definition corresponding to one used for the turn of the year period. These definitions were the seven-day return from the last trading day of the month through to the sixth trading day of the following month, the nine-day return from the last trading day of the month through to the eighth trading day of the following month, and the eleven-day return from the last trading day of the month through to the tenth trading day of the following month. The results are presented in table 2. They are very similar to the results of the comparison of turn of the year returns with non turn of the year returns. When the turn of the year returns are excluded, the turn of the month returns are not statistically significant in the pre-tax period. The difference in the ranks of returns is significantly different from zero at the 0.05 level for the seven-day and the eleven-day returns, but not for the nine-day returns. Thus, it appears that the turn of the year effect observed in the pre-tax period is independent of any turn of the month effect. 13As there is no constant phase relationship between days of the week and dates of the year, one may expect days of the week to be approximately evenly distributed during the turn of the year period. This is observed. For example, the 28 seven-day turn of the year periods prior to ;he introduction of the War Revenue -Act of 1917 include 31 Mondays, 33 Tuesdays. 3! Wednesdavs. 33 Thursdavs, 33 Fridavs and 35 Saturdays. Similar statistics aoplv to the nine-day and eleven-day turn of the year periods. Hence, the turn of the year effect is mdependent of the weekend effect [which has been documented by Cross (1973). Keim and Stambaugh (1984) and Harris (1986) among others].

TJ. Braikfivd

und S.A. Eastnn, Turn of the year effect

Table

139

2

Mean turn of the vear returns. mean turn of the month returns and tests for differences turn of the year and turn of the month returns. Days -1 to +6 Mean turn of year return (“b) Percentage positive Sample size Mean turn of month return (“,,)” Percentage positive Sample size MannWhitney

test statistic

for differences

19/R-I969 Mean turn of year return (“J Percentage positive Sample size Mean turn of month return (Y,,)” Percentage positive Sample size Mann-Whitney

test statistic

for differences

I918-1943 Mean turn of year return (“I,,) Percentage positive Sample size Mean turn of month return (“J” Percentage positive Sample size Mann-Whitney

test statistic

for differences

1944-1969 Mean turn of year return (Y,,) Percentage positive Sample size Mean turn of month return (“J” Percentage positive Sample size MannWhitney *Significant **Significant “Turn of the (World War

test statistic

for differences

0.71 71.4* 28 0.01 52.3 306

between

Days -1 to +8

Days -1 to +10

0.68 60.7 28 -0.11 49.0 306

1.13 71.41 28 -0.12 50.3 306

2.03*

1.54

2.29*

2.35 78.9** 52 0.19 X.7** 571

2.70 80.8** 52 0.22 56.7** 571

2.25 73.1** 52 0.16 54.3* 571

4.34+* 2.57 73.1* 26 0.19 56.1* 285 2.75+* 2.13 84.6** 26 0.20 57.3* 286 3.38**

at the 0.05 level (two-tailed test). at the 0.01 level (two-tailed test) month periods exclude all turn of the year periods 1) and 1933 (banking moratorium).

4.40** 3.11 80.8** 26 0.14 55.8 285 3.09** 2.28 80.8** 26 0.29 57.7* 286 3.17**

and the market

3.76+* 2.79 73.1* 26 0.00 53.7 285 2.59** 2.3 1 73.1* 26 0.33 54.9 286 2.79*+

closures

of 1914

A test was also conducted to determine whether the turn of the year effect is independent of the holiday effect. Three definitions of the return over a holiday period were employed, with each definition again corresponding to one used for the turn of the year period. These definitions were the seven-day return from the last trading day before the holiday through to the sixth trading day after the holiday, the nine-day return from the last trading day before the holiday through to the eighth trading day after the holiday, and the eleven-day return from the last day before the holiday through to the tenth trading day after the holiday.r4 The results, provided in table 3, are again similar to the previous results. When the turn of the year returns are excluded, the holiday returns are negative in the pre-tax period. The difference in the ranks of returns is again significantly different from zero at the 0.05 level for the seven-day and the eleven-day returns, but not for the nine-day returns. Thus, it appears that the turn of the year effect observed in the pre-tax period is independent of any holiday effect.

3.3. Dividends As the Railroad Index is a price index, it is possible that seasonality in dividend payments could induce seasonality in the observed rates of return.‘” average annualised dividend yields for To examine this proposition, each turn of the year, non turn of the year, turn of the month and holiday The differences in average annualised dividend period were computed.lh yields between each non turn of the year period and each turn of the year period, between each turn of the month period and each turn of the year period, and between each holiday period and each turn of the year period are reported in table 4. The dividend yields are higher in the seven-day and eleven-day turn of the year periods than in the corresponding non turn of the year periods. The differences in these dividend yields are - 1.64”‘fC,and -0.91”;,, respectively. The dividend yield is also higher in the eleven-day turn of the year period “The holiday periods exclude all Christmas Day and New Year’s Day holidays. all Saturday closures between 1945 and May 1952 (inclusive). and all special Wednesday closures during 1968 (from June 12). Further, the market was closed from I August 1914 to 11 December 1914 because of World War I, and closed from 4 March 1933 to I4 March 1933 because of a banking moratorium. These latter closings were also not treated as holiday closings In the reported results. However. running the analysis with these closings included as holiday closings had virtually no effect on the results. “As the evidence of a turn of the year effect in the pre-tax period is inconsistent with previous research. and as this evidence leads to rejection of the tax-loss selling hypothesis as a complete explanation of the effect, the focus of this section of the paper is on the pre-tax period only. “Over the period 1897 to 1917. stocks comprising the Railroad Index went ex-dividend on 730 occasions. The average annualised dividend yield from these ex-dividend dates was 2.71 Oo.

141

Mean turn of the year returns, mean returns of the year returns

Mean turn of year return (I’,,) Percentage positive Sample size Mean holiday return (“,,I” Percentage positive Sample srze Mann-Whitney

test statistic

for differences

IYIN IY& Mean turn of year return (‘I,,) Percentage positive Sample size Mean holiday return (I’,,)” Percentage posttive Sample size Mann

Whitney

test statistic

for ditTerences

over holidays and tests for differences and returns over holidays

between

turn

Days -I to +6

Days -1 to +x

Days -I to +10

0.7 I 71.4* 28 -0.09 43.8* 242

0.68 60.7 28 -0.15 46.7 242

I.13 71.4* 28 - 0.23 48.8 242

2.51* 2.35 78.9** 52 ~ 0.06 52.6 489 4.84**

1.78 2.70 80.8** 52 -0.01 51.9 489 4.69**

2.48* 2.25 73.1** 52 -0.12 53.6 489 4.04**

IYIX I943

Mean turn of year return (‘I,,) Percentage positive Sample size Mean hohday return (“,,)” Percentage positive Sample size Mann-Whitney

test statistic

for differences

IY44mlY6Y Mean turn of year return (‘I,,) Percentage positive Sample size Mean holiday return (“,,)” Percentage positive Sample size Mann

Whitney

test statistic

for differences

2.57 73.1* 26 -0.12 50.9 275 3.35** 2.13 84.6** 26 0.02 54.7 214 3.53**

3.1 I 80.8** 26 -0.14 49.1 275 3.51** 2.28 80.8** 26 0.17 55.6 214 3.12**

2.79 73.1* 26 -0.21 53.1 275 2.79** 2.31 73.1s 26 -0.00 54.2 214 2.97**

*Significant at the 0.05 level (two-tailed test). **Significant at the 0.01 level (two-tailed test) “Holiday periods exclude all Christmas Day and New Year’s Day holidays, all Saturday closures between 1945 and May 1952 (inclusive), all special Wednesday closures during 1968 (from June 12). and the market closures during 1914 (World War I) and 1933 (banking moratorium).

142

TJ. Brailsjiird and S.A. Easton, Turn qfthe year e&r Table Differences

in average

Non turn of year vs. turn of year Seuen-day period Dividend yieldb Lower bound’ Eleven-day period” Dividend yieldb Lower bound’

4

annual&d

dividend

yields.

Turn of month vs. turn of year

Holidays vs. turn of year

- 1.64 2.49

0.58 1.18

0.13 9.53

-0.91 3.16

0.38 3.33

-0.29 7.05

“The seven-day and eleven-day periods are the periods from the last trading day through to the sixth and tenth trading days, respectively, surrounding the specific calendar period. Dividend yields were not computed for nine-day periods because the return over the turn of the year period was not significantly different from the return over any of the comparable nine-day periods. bThe dividend yield difference is calculated as the difference between the average annualised dividend yield implied from dividend yields over the non turn of the year, turn of the month and holiday periods and the average annualised dividend yield implied from dividend yields over the turn of the year period. ‘The lower bound is from the Mann-Whitney 95% confidence interval from the test of differences between returns over the seven-day and eleven-day turn of the year periods and returns over the comparable seven-day and eleven-day periods.

than in the eleven-day holiday period. Table 4 also reports the lower bound of the 95% confidence intervals for the Mann-Whitney tests for differences in ranks of returns, where these differences have been converted into annual percentages. While the average annualised dividend yields are lower in the turn of the year periods than in the corresponding turn of the month periods, the differences are all less than the lower bound of the 95% Mann-Whitney confidence intervals. This is also true for the difference between the seven-day turn of the year period and the seven-day holiday period. Therefore, the null hypotheses of no difference in returns (capital gain and dividends) between the seven-day and eleven-day turn of the year periods, and the comparable seven-day and eleven-day (non turn of the year, turn of the month and holiday) periods can still be rejected. 4. Summary The turn of the year effect is an empirical regularity that has yet to be fully explained. A common explanation that has been put forward is the tax-loss selling hypothesis. Whilst acceptance of the hypothesis on theoretical grounds has been less than overwhelming, it has been the subject of empirical tests. Three studies have tested this hypothesis by examining equity returns before and after the introduction of the War Revenue Act of 1917. However, these studies have reached inconsistent conclusions. Schultz (1985), using daily data, found no evidence of high returns around the turn of the year before the introduction of the Act, whereas Pettengill (1986) and Jones

TJ. Brailsford and S.A. Easton, Turn of the year eflect

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et al. (1987), using monthly Cowles Commission data, found evidence of significantly high returns in January before the introduction of the Act. Following these inconsistent findings, this paper has examined whether the Schultz finding is robust to the extension of the pre-tax period, or whether the finding of Pettengill and Jones et al. is robust to the use of daily data. In this study, we have extended Schultz’s study period by examining daily returns on the Dow Jones Railroad Index over a 28-year pre-tax period compared to his 18-year pre-tax period. In contrast to Schultz’s findings, a significant turn of the year effect is found prior to 1917. Furthermore, this effect is shown to be independent of other empirical regularities such as the turn of the month effect and the holiday effect, and seasonality in dividend payments cannot explain the finding. A strong turn of the year effect in the post-tax period was found, and this finding may reflect tax-loss selling. However, the existence of a turn of the year effect prior to the introduction of the War Revenue Act of 1917 suggests that the tax-loss selling hypothesis can only provide, at best, a partial explanation.

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