Equity Returns at the Turn of the Month: Trading Strategies and Implications for Investors and Managers

2006 Institute for Quantitative Research in Finance Meetings (Q-Group)

91 Pages Posted: 23 Aug 2006

Date Written: August 20, 2006

Abstract

We propose to extend and complete the attached study of the "turn-of-the-month" effect in equity returns in two ways. First, we propose to study whether the effect is more pronounced among certain industries where industries are determined by SIC codes and/or the Fama-French industry classifications and/or whether the effect is more pronounced in certain time periods especially periods of 'high' investor sentiment. Second, we propose to investigate whether the effect can be used to generate a profitable trading strategy after trading costs. This latter investigation will examine three low cost strategies:

1. a strategy of switching between an equity fund and a bond fund of the same mutual fund family; 2. a strategy of buying and selling exchange traded funds (ETFs), either specific styles of ETFs or market-based ETFs; and 3. a strategy of buying and selling equity index futures.

We propose to consider the implications of these for fund managers especially funds that might be exposed to being "picked off" by a turn-of-the-month trading strategy.

The turn-of-the-month effect in U.S. equity returns was initially identified by Ariel (1987), who studies CRSP market returns over the period 1963-1982, and Lakonishok and Smidt (L&S) (1988) who study DJIA returns over the period 1897-1986. According to the turn-of-the-month effect, equity returns over the interval beginning with the last trading day of the month and ending three days later are unusually high. For example, L&S report that over the 90-year period covered by their study, the average cumulative return over the four-day turn-of-the-month is 0.473% whereas the average cumulative return over the full month is 0.349%, indicating that returns were, on average, negative over the remaining days of the month.

In the attached study, we extend and broaden the Ariel and the L&S analyses using CRSP daily market returns for the period 1926-2006. To begin, we find that the effect occurs over the two decades that begin after the periods studied by them. For example, with VW returns, over the period 1987-2005, the mean daily market return over the four-day turn-of-the-month is 0.15%; whereas over the other 16 trading days, it is -0.001%. When our results are combined with those of L&S, on average, investors receive no reward for bearing market risk except at the turn-of-the-month over the 109-years of 1897-2005.

We find that the effect is not confined to small-cap or low-price stocks; it is not concentrated at calendar year-ends or quarter-ends; and it is not confined to the US: of the 34 countries we study, the effect occurs in 30 of them. Further the effect is not due to risk as measured by standard deviation of returns. Finally, we find that the effect is not due to increased buying pressure measured by trading volume and net flows to mutual funds. We propose to extend and complete this study as described above.

Keywords: turn of the month effect, equity return, trading strategy, industry effect

JEL Classification: G1, G13, G14

Suggested Citation

McConnell, John J., Equity Returns at the Turn of the Month: Trading Strategies and Implications for Investors and Managers (August 20, 2006). Available at SSRN: https://ssrn.com/abstract=925589 or http://dx.doi.org/10.2139/ssrn.925589

John J. McConnell (Contact Author)

Purdue University ( email )

MGMT, KRAN
403 West State St.
West Lafayette, IN 47907-2056
United States
765-494-5910 (Phone)
765-494-7863 (Fax)

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