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CALENDAR EFFECTS in CHINESE STOCK MARKET 77 End Effect in the Case of China Would Contradict the Former Explanation Concerning the Year-End Effect

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CALENDAR EFFECTS in CHINESE STOCK MARKET 77 End Effect in the Case of China Would Contradict the Former Explanation Concerning the Year-End Effect ANNALS OF ECONOMICS AND FINANCE 6, 75{88 (2005) Calendar E®ects in Chinese Stock Market Lei Gao Institute of Behavioral Finance, College of Business, Hangzhou Dianzi University Zhejiang, 310018, P.R. China E-mail: [email protected] and Gerhard Kling Utrecht School of Economics, Netherlands E-mail: [email protected] Our paper examines calendar e®ects in Chinese stock market, particularly monthly and daily e®ects. Using individual stock returns, we observe the change of the calendar e®ect over time. In Shanghai and Shenzhen, the year- end e®ect was strong in 1991 { but disappeared later. As the Chinese year-end is in February, the highest returns can be achieved in March and April. Study- ing daily e®ects, we found that Fridays are pro¯table. Chinese investors are \amateur speculator" who often embezzles business fund for private trading; thus, these funds are used for short-term speculations before they are paid back prior to weekends. °c 2005 Peking University Press Key Words: Year-end e®ect; China, Anomalies; Tax-loss selling. JEL Classi¯cation Numbers: K22, G28, C22. 1. INTRODUCTION Capital market e±ciency has been a very popular topic for empirical research since Fama (1970) introduced the theoretical analysis of market e±ciency and proclaimed the E±cient Market Hypotheses. Subsequently, a great deal of research was devoted to investigating the randomness of stock price movements for the purpose of demonstrating the e±ciency of capital markets. Since then, all kinds of calendar anomalies in stock mar- ket return have been documented extensively in the ¯nance literature. The most common calendar anomalies are the January e®ect and the day of the week e®ect. Showing that market returns follow a seasonal pattern 75 1529-7373/2005 Copyright °c 2005 by Peking University Press All rights of reproduction in any form reserved. 76 LEI GAO, GERHARD KLING violates the assumption of weak market e±ciency in that by observing the past development of returns market participants can make extraordinary pro¯ts. Accordingly, Haugen and Jorion (1996) suggested that calendar ef- fects should not be long lasting, as market participants can learn from past experience. Hence, if a monthly e®ect exists, trading based on exploiting a monthly pattern of returns should yield extraordinary pro¯ts { at least for a short time. Yet such trading strategies a®ect the market in that fur- ther pro¯ts should not be possible: the calendar e®ect should break down. Nevertheless, Haugen and Jorion (1996) found that the January e®ect still exists. Changes of calendar e®ects over time are of major interest for our paper. The literature on monthly e®ects, generally, con¯rmed the January and year-end e®ect, which is related to tax-loss selling strategies and behav- ioral aspects. Roze® and Kinney (1976) demonstrated that stock returns of the US stock markets are in the ¯rst month of the year signi¯cantly larger compared to other months. Other major capital markets in devel- oped countries exhibit similar calendar e®ects: O±cer (1975) focused on the Australian Stock Exchange; Tinic, Barone-Adesi and West (1990) on the Canadian market; Aggarwal, Rao and Hiraki (1990) on the Tokyo Stock Exchange; Barone (1990) on the Italian market and Lewis (1989) analyzed stocks listed on the London Exchange. The literature on the so-called disposition e®ect { that losers are hold too long and winners are sold to early { also refers to a year-end e®ect (see Odean, 1998).1 One explana- tion of the higher returns in January is the tendency to realize losses in December to reduce the taxable speculation gains. Another e®ect is win- dow dressing, which is related to institutional trading.2 To avoid reporting to many losers in their portfolios at the year-end, institutional investors tend to sell losers in December. They buy these stocks after the reporting date in January to hold their desired portfolio structure again. This yields higher returns in January compared to other months. Due to the fact that taxation of capital gains is common in all developed countries, China can act as a counter example in that capital gains are free of taxes. Hence, tax motivated selling should not be observable on the Chinese stock ex- changes in Shanghai and Shenzhen. Furthermore, the Chinese year-end is in February, and institutional trading is less important compared to other stock markets.3 Consequently, the above-mentioned explanations for the year-end e®ect do not apply to the Chinese stock market. Finding a year- 1Shefrin and Statman (1985) introduced the term disposition e®ect. 2Among others Dyl (1977), Gompers and Andrew (2001), and Lakonishok et al. (1991) stressed the importance of the taxation and window dressing issue for the observed year- end e®ect. 3Kling and Gao (2004) found that institutional investors play a negligible role in the Chinese stock market. CALENDAR EFFECTS IN CHINESE STOCK MARKET 77 end e®ect in the case of China would contradict the former explanation concerning the year-end e®ect. Our paper tries to ¯nd or reject the year- end e®ect using Chinese stock market data. Henceforth, we contribute to understanding the year-end phenomenon. There is also a large body of literature on the day of the week e®ect of stock returns. Cross (1973) found that the mean return on Friday was higher than the mean return on Monday of the S&P 500 Index during the period from 1953 to 1970. This e®ect is usually called the weekend e®ect. French (1980) who also investigated the S&P 500 index veri¯ed this ¯nd- ing for the period from 1953 to 1977. Later, Gibbons and Hess (1981) and Smirlock and Starks (1986) reported similar results. The day of the week e®ect is also observed in stock markets of other countries. Ja®e and Wester- ¯eld (1985) examined the weekend e®ect in Australian, Canadian, Japanese and UK equity markets, and found that the lowest mean returns for both Japanese and Australian stock markets were on Tuesdays. Solnik and Bous- quet (1990) also demonstrated a strong and persistent negative return on Tuesday in the case of the Paris Bourse. Barone (1990) con¯rmed these results that identi¯ed the largest decline in Italian stock prices mostly on Tuesday. Afterwards, Agrawal and Tandon (1994), Alexakis and Xanthakis (1995), and Balaban (1995) showed that the distribution of stock returns varies dependent on the respective day of the week for various countries. Moreover, the day of the week patterns are present in other US ¯nancial markets including the T-bill market (Flannery and Protopapadakis, 1988), the commodity and stock futures markets (Cornell, 1985; Dyl and Maberly, 1986; Gay and Kim, 1987). In brief, the day of the week e®ect is a com- mon phenomenon across di®erent countries and di®erent types of markets. The special features of the Chinese stock market make an investigation of the day of the week e®ect promising. Especially, the speculative behavior and the dominance of small shareholders could a®ect the day of the week e®ects. The purpose of our paper is to investigate the calendar e®ects in Chinese stock market; thereby, using index data and individual stock returns of the Shanghai and Shenzhen stock exchanges. Besides providing a somewhat static picture on the calendar e®ects, which has not been done thoroughly thus far, we study the change of calendar e®ects over time. As Haugen and Jorion (1996) pointed out that one should expect that calendar e®ects are short-term phenomena due to the learning of market participants. If investors based on past experience are aware of calendar anomalies and can run trading strategies, such e®ects should disappear over time. The rest of the paper is organized as follows. Part 2 introduces the datasets and discusses the use of individual and market index data for analyzing the current calendar e®ects and their change over time. Part 3 takes up the monthly e®ects; hereby, we start with a descriptive analysis followed 78 LEI GAO, GERHARD KLING by regression analyses and estimates for the change of monthly e®ects over time. The empirical ¯ndings for the day of the week e®ect follow. Then, section 5 proposes explanations for calendar anomalies in the Chinese stock market. Finally, concluding remarks summarize our main ¯ndings. 2. DATA To analyze monthly and daily e®ects in stock returns, we use the market index of the Shanghai and Shenzhen stock exchanges, which is common in the literature. However, to measure the changes of calendar anomalies over time relying on index data is insu±cient due to data availability. Obviously, having at best 13 observations for every months since the reopening of the stock exchanges in the 1990s makes it a risky venture to estimate changes of monthly e®ects over the 13 years. Hence, we use in addition individ- ual stock returns of all stocks listed on both exchanges since the restart of security trading in China. This increases the number of observations dramatically, and one obtains precise estimates for the shift of monthly patterns over time. TABLE 1. Descriptive monthly statistics on average returns and their con¯dence intervals Shanghai Shenzhen Months Lower Mean Upper Lower Mean Upper January ¡4:87 3.98 12.84 ¡5:49 1.34 8.17 February ¡0:77 3.38 7.53 ¡2:49 2.66 7.82 March ¡8:70 0.35 9.41 ¡4:27 3.55 11.37 April ¡4:07 5.41 14.89 ¡5:05 7.70 20.45 May ¡12:53 8.17 28.87 ¡5:46 2.61 10.69 June ¡4:97 3.49 11.94 ¡9:15 0.03 9.21 July ¡13:33 ¡5:90 1.53 ¡12:46 ¡4:78 2.89 August ¡10:60 6.60 23.80 ¡10:25 0.81 11.86 September ¡6:34 ¡2:07 2.21 ¡6:36 ¡2:42 1.52 October ¡11:40 ¡2:91 5.58 ¡9:50 4.46 18.42 November ¡1:16 6.68 14.53 ¡2:71 1.64 6.00 December ¡9:46 ¡3:94 1.57 ¡9:70 ¡4:14 1.42 All values are in percentage points.
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