1

The Efficiency and Characteristics of the Asian

and US Stock Markets
--- Seoul, Tokyo, Jakarta, Shanghai, and New York ---

Kilman Shin*

In 1968, " the prevailing view among academic economists, even at the University of
Chicago, was that the stock market was not a proper subject of serious study." Ray Ball,
"The Theory of Stock Market Efficiency: Accomplishments and Limitations", in The
Revolution in Corporate Finance, 4th ed., 2003, p.12

Abstract

The January effect refers to the theory that the monthly average stock return is the highest
in January than in any other month. Some argue that the January effect holds true only for
small-firm stocks and it takes place only over the first week of a new year. Others argue
that the January returns are higher because the risk is higher in January. The January
effect has received much attention since it directly contradicts the random walk theory,
which argues that future stock prices are unpredictable using the present and past price
information. Defendants of the random walk theory argue that the January effect can last
only in the short run and it cannot persist and will disappear in the long run. In this study,
the following stock markets are examined: Korea, Tokyo, Jakarta, and Shanghai, and US
stock markets (SP500, Dow-Jones, NASDAQ, and SP500 Total return index). To find if
the January effect or any other periodic patterns exist in these markets, monthly stock
returns are compared with and without risk-adjustments. Also, various statistical methods,
such as correlation, regression, autocorrelation, runs test, variance ratio test, unit root test,
Johansen cointegration test, ARIMA, VAR, ARCH, ARCH-M, GARCH, spectral
analysis, and factor analysis are applied to the monthly stock prices and returns. For risk-
adjustment, the Shin index is proposed with regard to the Sharpe index, Treynor index,
Jensen index, and the Modigliani index.

I. Introduction

A large number of empirical studies have been published on the January effect
which is a theory that monthly stock returns tend to be higher in January than in any other
month. The so-called January effect has received much attention since it contradicts the
random walk hypothesis which argues that stock returns should be independent
_______________________________________________________________________
* Ferris State University, Big Rapids, Michigan, 49307 USA: kilman_shin@ferris.edu
The paper was presented at the joint conference of the Korean Financial Management
Association, Korean Securities Association, and Korea/America Finance Association,
May 30, 2003, Chonan, Korea

2

of the past returns. The random walk hypothesis implies the following propositions when
applied to monthly returns: First, a given month's stock returns should have no significant
correlations with other months' stock returns so that one month's stock return is useless in
predicting the stock returns of other future months. Second, monthly stock returns should
have no seasonality, periodic or cyclical patterns so that future stock returns cannot be
predicted based on periodical patterns. Third, if international stock markets are globally
efficient, their stock returns of the same month may be correlated if they have close
economic relationships. But a country's stock returns of a given month should be useless
to predict stock returns of future months of other countries (see appendix notes).
To support or refute the random walk hypothesis, there are much on-going
research in the periodical patterns in the stock returns in the following areas: (1) the
January effect monthly or daily stock returns are higher in January than in other months,
(2) Early month effect stock prices rise during the first 2 weeks of each month, (3)
Week-end effect stock prices fall on Monday relative to Friday (pure week-end effect,
Friday close to Monday open), (4) Day-end effect stock prices rise near the closing time,
(5) Holiday effect stock prices rise on the day before the national holiday weekends,
and (6) Daylight savings time effect stock prices fall after the change in the daylight
savings time (Kamstra, Kramer, and Levi, 2000, 2002; Pinegar, 2002; for a review, see
Khaksari and Bubnys, 1992; Malkiel, 2003).

The efficient market hypothesis is based on two assumptions: (1) all relevant
information is free and available to all investors simultaneously, and (2) there are many
competitive investors (Fama, 1965, 1970). Since information may not be freely available
and there may be less competitive investors in the emerging stock markets, it is often
argued that stock markets in emerging countries may not be efficient. The major
objective of this paper is to examine some selected Asian stock markets to find if there
are any monthly or seasonal patterns, such as the January effect, and if the stock prices
follow the random walk. The following Asian stock markets are selected for our study:
the Korea (Seoul) Stock Exchange, the Tokyo Stock Exchange, the Jakarta Stock
Exchange, and the Shanghai Stock Exchange. The US stock market (SP 500 stocks, Dow-
Jones 30 industrial stocks, NASDAQ stocks, and SP500 total return index) is also
examined in this study for the purpose of comparison (see appendix notes). In section II,
some of the previous empirical studies are reviewed. In section III, the random walk
theory and the methods of measuring risk-adjusted returns (CAPM) are reviewed. In
section IV, empirical results are presented for the Asian and US stock markets. A
summary and conclusions are provided in section V.

II. Review of Previous Studies

There are many studies on the seasonality and cyclical patterns in the monthly,
weekly, and daily stock returns. Some early studies are reviewed in Wachtel (1942),
Granger and Morgenstern (1970). Since Wachtel (1942) is widely quoted as an early
proponent of tax-selling hypothesis, we will briefly review his study. His study is based
on the following assumptions: (1) The high-yielding stocks are usually the stocks whose
prices have decreased, and they are the best stocks to sell in December to obtain the
3
largest realizable capital losses for tax saving, (2) individuals and corporations sell stocks
for tax-saving toward the middle of December to establish tax losses, and such pressures
drives security prices below what they should be in the light of potential earnings, (3) the
rise at the year's end is nothing more than a normal reaction from depressed levels.

To prove the above theory, he selects 20 highest-yielding industrial stocks listed
on the NYSE each year for the period 1927-42. Then he adds the values of the 20 stocks
at every 2 weeks from the bases in December, and divides by 13 years (1927-42) to
obtain the annual mean value. This procedure was followed to obtain the mean values for
the 30 Dow-Jones Industrial stocks. He then plots the series of the two mean values at 2-
week time interval. He finds that the mean value of the high-yielding stocks rise more
than the low-yielding Dow-Jones stocks in the late December to the third Saturday in
January. Similar results were obtained for the median values. However, the following
criticism may be made. First, there is no reason why the tax selling pressure should end at
the middle of December. In theory, the tax-selling pressure should continue until the end
of December. As another possible reason, Wachtel mentions unusual demand for cash,
beginning a week or two before Christmas, causes many stock sales. But his data show
that stock prices rise 2 weeks before the year end. That is, unusual demand for cash
should not stop until the holiday season is over. Second, there is no statistical significance
test. So we can not tell whether thee difference is statistically significant.

Granger and Morgenstern (1963,1970) reviewed some early studies on the
periodical patterns in the stock market. To examine the validity of such studies, they
applied spectral analysis to various data, such as the Standard and Poor's Stock Index
(Monthly, 1871-1956, 1918-64), SEC Stock Price Index (weekly, 1939-64), Dow-Jones
Industrial Average (1915-1961), and individual company stocks (daily, weekly, and
monthly). They plotted and examined several spectral diagrams, and concluded that the
spectra of log price differences are flat for all series considered over a range of 0.5 cycles
per year up to 0.5 cycles per day, strongly supporting the random walk hypothesis. The
results did not show a 12 month peak, though it showed some small peaks corresponding
to a three month cycle. Weekly price series indicated the presence of a small monthly
cycle. But none of the cycles was significant in any spectral diagram (pp. 130-131).

Bonin and Moses (1974) used the analysis of variance for the monthly data of
the 30 DowJones industrial stocks for the period 1962-71, and found that 7 of the stocks
displayed significant seasonal patterns. Officer (1975) used the Box-Jenkins time series
analysis for the Australian stock returns for the period 1958-70, and found 6-month, 9-
month, and lesser 12-month seasonality in the autocorrelation function.

Rozeff and Kinney (1976) used the NYSE data for the period 1904-74. They
divided the sample into 4 periods: 1904-28, 1929-40, 1941-74, and 1904-28 plus 1941-74.
When they computed the autocorrelation functions, the results did not reveal seasonality.
However, when average monthly returns were tested, except for the period 1929-40, they
found statistically significant differences in the monthly returns due to the large January
returns. They used the Kruskal-Wallis test, the Siegel-Tukey test, Bartletts test for
homogeneity of variances, and the analysis of variance. They found that the January
4
return is significantly higher than other month's returns. They also found relatively higher
returns in July, November, and December, and low returns in February and June. Also,
January had a relatively higher risk premium than other months. They also tested the
CAPM adjusted returns, and found significant monthly differences.

Dyl (1977) selected 100 stocks for the period 1959-70 and divided into 3
portfolio groups based on the percentage change in stock prices: portfolio 1, price
increased more than 20%; portfolio 2, price changed between 20% and -20%, and
portfolio 3, price decreased more than 20%. He found that the stocks whose prices
decreased more than 20% during the year had abnormally higher trading volumes in
December. He argued that it was evidence that investors sell to realize the capital losses
for the purpose of tax deduction. He measured abnormal volume as the actual volume as
a percentage of average monthly volume. Branch (1977) examined year-end lows of
NYSE stocks and found the average excess returns of 3.5% to 6.2% for the periods of one
to four weeks following the last Friday of the year over the period 1965-75. Branch and
Ryan (1980) examined tax-loss selling candidates of NYSE and AMEX stocks for the
period 1965-78. They found that such stock prices rose on the first 4 weeks of the year.
The selected NYSE stocks increased from 3.4% to 6.7%, and the selected AMEX stocks
rose from 5.2% to 14.4%.

Keim (1983) used the NYSE and AMEX data for the period 1963-79. He divided
the stocks (1,500 to 2,400 in total) into 10 portfolio groups. He regressed the daily excess
returns on the 11 dummy variables, where each dummy variable represents each month
from February to December. The excess return for January is measured by the intercept
constant. He found that the January effect is significant for small-firm portfolios (1 to 4
deciles) and the excess returns are negatively related to larger firms (5 to 10 deciles). He
also found that the January effect occurred during the first 5 trading days of the year. He
used 3 types of beta, namely, the OLS estimated beta, Scholes-Williams beta, and
Dimson beta to calculate the risk adjusted excess returns for the portfolios of small firms
(see appendix note).

Roll (1981) argues that the stocks of small-size firms are infrequently traded, and
as a result the systematic risk is underestimated. As a result, the beta-risk adjusted returns
are overestimated. Using the SP500 data for the period 1963-77, he shows that the
Dimson beta is higher than the ordinary beta about 1.25 to 2.37 times. Roll (1983)
compares the daily stock returns for the last trading day of December and the first 4
trading days of January (turn-of- the year). He found that the very first day of January
showed the largest mean return differences. He found that the January effect is significant
for both small and large firms. The mean and the frequency of positive returns on the 5
trading days were larger on the AMEX stocks. Roll infers that the January effect may
persist because the relative trading cost is larger for the smaller firms than for the larger
firms.

In Australia, all tax-paying financial institutions pay normal taxes on capital gains,
and capital losses are deductible without limit from ordinary income. Individual investors
do not pay taxes on capital gains. Also, the Australian tax year is July 1 to June 30. Thus,
5
to support the tax-selling hypothesis, there should be a June-July effect. Brown, Keim,
Kleidon, and Marsh (1983) investigated the Australian stocks for the period 1958-81. To
allow for the size effect, the stocks were divided into 10 groups of portfolios. They found
that the smallest decile of firms had average returns of 6.754%, while the largest decile of
firms had 1.028 %. Also, they found higher returns over December-January and July-
August. Thus, they concluded that the January effect is not due to tax-selling activities.

Gultekin and Gultekin (1983) examined monthly stock returns for 17 countries:
Australia, Austria, Belgium, Canada, Denmark, France, Germany, Italy, Japan,
Netherlands, Norway, Singapore, Spain, Sweden, Switzerland, UK, and the US. They
used the Capital International Perspective data, published by Capital International, S.A.,
located in Geneva, for the period 1959-79. The return data are based on the value-
weighted indexes of month-end closing prices without dividend yields. They computed
first 12 monthly autocorrelations, and found that they were mostly not significant except
for Australia, Denmark, and Norway. They used the Kruskal-Wallis test for the 17
countries, and found that the monthly returns are not equal for 12 countries from a total
of 17 only at the 10% level. The monthly returns were equal for Australia, France, Italy,
Singapore, and the US. Except for Australia, they the monthly returns were higher at the
beginning of the tax year. In Australia, the tax year starts in July, and in the UK, it starts
in April.

Berges, McConnell, and Schlarbaum (1984) used Canadian stocks for the period
1951-80. In Canada, the capital gains tax was installed in January 1973. They divided
391 stocks into 5 portfolio groups, and compared the January monthly returns with means
of February-December returns for the period 1951-72 and for the period 1973-80. They
found that the January returns are higher for each portfolio group than for the February-
December returns. Also the January returns were higher for the period 1973-80 than for
the period 1951-72. The capital losses in excess of capital gains may be used to offset
ordinary income up to a maximum of $2,000 in one tax year. Thus, there was no
incentive for Canadian investors to sell stocks at the end of the tax year prior to 1973. But
they found the January effect which was more pronounced for small-size firms. Thus,
they conclude that tax-selling hypothesis is not a complete explanation for the January
effect.

Tinic, Barone-Adesi, and West (1987) also used Canadian stocks for the period
1950-81. They divided 317 stocks into 5 size-portfolios. They used regression analysis
with 5 dummy variables: 3 dummy variables representing for January, December, and
the period 1973-80 with capital gains tax respectively. Two other dummy variables are
the product of January dummy and the capital gains tax period dummy variable, and the
product of the December dummy and the capital gains tax period dummy variable. The
results showed that stock returns are higher in January and December and the smaller
firms have higher returns than the large firms. The dummy variable representing the
capital-gains tax period had positive signs, but it was not statistically significant except
for one portfolio. They conclude that the results do not support tax-loss selling as the sole
factor of seasonality, but they provide limited support for tax loss-selling hypothesis.

6
Kato and Shallheim (1985) examined data (about 529 to 844 stocks) for the
period 1964-81. They divided the stocks into 10 portfolios based on market capitalization.
They calculated regression equations with monthly dummy variables. They found
January and June returns are significantly higher than other monthly returns. In Japan,
there is no capital gains tax for individual investors, but corporations are taxed on capital
gains, and each firm can choose its tax year arbitrarily. About 50% of Japanese firms
choose tax years ending Mach 31. Thus, the Japanese results do not necessarily support
the tax-selling hypothesis. They present two possible reasons for the January and June
effects. First, most Japanese firms pay so-called bonuses equivalent to about two monthly
salaries to employees generally in June and December. Second, corporate earnings
forecasts are made by financial analysts in March, June, September, and December. They
state that these factors may partly explain the January and June effects.

Jaffe and Westerfield (1985) calculated daily returns for Tokyo stocks for the
period 1970-83. They found that the January mean daily return 0.0013 was significantly
higher than the overall daily average return 0.00035. However, there was no significant
difference between the average returns over the last 5 days of December and the first 5
days of January. They also calculated the correlations coefficients between the Tokyo
stock daily returns and the SP500 daily stock returns. The correlation coefficient was the
highest for the contemporaneous calendar time at 0.154, with was highly significant
(t=8.76). As for the day of the week effect, the lowest daily mean return occurred on
Tuesday in Tokyo, and the lowest mean return occurred on Monday in New York,

Keim (1985) used the NYSE stocks for the period 1931-78. He regressed the
January stock returns on the systematic risk beta, dividend yield, dummy variable that is
equal to 1 if the firm pays zero dividend and is equal to zero otherwise, and the natural
log of the market value of the security. He found that the intercept, dividend yield, and
presence of dividend payment were positively correlated, but the firm size was negatively
correlated. The systematic risk was not significant. When the Feb.Dec. returns were
regressed on the same independent variables, the firm size was significant and negatively
correlated. Dividend variables and the systematic risk were not significant.

Arbel (1985) collected 1,000 companies: SP500 stocks and non-SP 500
companies for the period 1971-80. The SP 500 companies are divided into highly
researched, moderately researched, and research-neglected companies. The non-SP 500
companies are all research-neglected companies. He found that the January returns were
higher for neglected companies. For the SP 500 stocks, the January returns were 2.48%
for the highly researched companies, 4.95% for the moderately researched companies,
and 7.62% for the neglected. The January returns were 11.32% for the non-SP 500
neglected companies. Branch and Chang (1985) found that stocks whose prices were
falling throughout the year tended to rise in price in the first 4 weeks of the following
year. The January effect was found in many other studies.

Lakonishok and Smidt (1986) used the daily stock data of the Chicago tape for the
period 1970-81. They divided the stocks into 10 deciles and calculated daily returns over
the last 5 days and the first 4 days around the turn of the year using three methods of
7
calculating the daily return: CRSP return, close-to-close, and open-to-open. They found
that the returns of small companies are high around the turn of the year and are higher
than the returns of large firms, no matter how returns are measured.

Chang and Pinegar (1986) examined the holding period returns of the bonds
traded on the NYSE for the period 1963-82. They stratified the bonds into 6 groups
according to Moody's bond rating system: Aaa, Aa, A, Baa, Ba, and B. They found that
the January returns are pronounced for the Baa and B-rated bonds. They also examined
stock returns of the firms whose bond returns were evaluated. The differences in the
stock returns were not significant when the analysis of variance was applied. But when
they compared the January returns with the average of the previous 11 monthly returns,
the t-values were significant for 3 of the 6 stock portfolios.

Lo and MacKinlay (1988, 1989) applied the variance ratio test to weekly data for
the period Sept. 2, 1962 to Dec. 26, 1985 and 2 subperiods. For the equal-weighted index
for the NYSE and AMEX stocks, the variance ratio test did reject the null hypothesis of
the random walk. But, the results were mixed for the value-weighted indexes. They also
examined 625 stocks and 3 size-sorted portfolios, each of which contained 100 stocks:
small stocks, medium stocks, and large stocks. The results showed that the returns of
individual returns and the 3 portfolio returns were not statistically significant, meaning
that they follow the random walk. However, for the equal-weighted portfolios of 625
stocks, the random walk hypothesis was rejected, and the value-weighted portfolios were
supported for the random walk. However, Lo and Mackinlay (1999, p. 16) state that " the
most current data (1986-1996) conform more closely to the random walk than our
original 1962-1985 sample period."

Branch and Chang (1990) used the Compustat data for the period 1971-83. Using
regression analysis, they found that low-price stocks that exhibited poor December
performance are likely to rebound in January. They argue that an efficient market will
not necessarily eliminate such predictable price patterns due to the following factors:
transaction costs (commission and bid-ask spreads), search costs (costs of identifying
such stocks), and differential capital gains tax rates (high marginal tax rates).

Khaksari and Bubnys (1992) use daily data for the SP500, NYSE stock indexes,
and stock index futures for the period 1982-1988 to test the day-of-the-week, day-of-the-
month, and month-of-the-year effects on stock indexes and stock index futures. They use
the Sharpe index to obtain risk adjusted returns. They find that the day-of-the-week and
the day-of-the-month effects are more pronounced in the futures indexes than in the spot
indexes. However, the January effect was more evident in the spot indexes than in the
futures indexes. They conclude that the use of the Sharpe ratio sharply reduces the day-
of-the-week effect in spot and futures index returns, but it does not reduce the month-of-
the-year effect. They state that these results tend to disagree with efficient market
proponents.

Ojah and Karemera (1999) apply the variance ratio test of Lo and MacKinlay
(1988), multiple variance ratio test of Show and Denning (1993), and auto-regressive
8
fractionally integrated moving average test of Geweke and Porter-Hudak (1983) to the
monthly data of Latin American countries for the period 1987-1997. The results
supported the random walk hypothesis for Argentina, Brazil, and Mexico, but not for
Chile. Yilmaz (2001) use weekly data for the period 1988-2000 and applied the variance
ratio tests to 14 emerging stock markets. The random walk hypothesis was accepted for
Indonesia, Korea, Malaysia, Taiwan, Argentina, Brazil, Mexico, Japan, and USA, but it
was rejected for the Philippines, Thailand, Chile, Greece, and Turkey at the 5 % level.
Hall and Urga (2002) test the Russian stock market with monthly data for the period
1995-2000. They used a time varying parameter model with changing intercept and slope
coefficients (AR(1) with generalized autoregressive conditional heteroscedasticity-in-
mean-GARCH-M). They find that the stock market indexes are initially inefficient and
predictable, but two and a half years later it becomes efficient (see appendix note).
Mookerjee and Yu (1999) test the Shanghai and Shenzhen stock exchanges with daily
data ( Dec. 19, 1990-May 20, 1992 for the Shanghai stocks, and April 3, 1991 - Dec. 17,
1993 for the Shenzhen stocks). They applied the ARIMA models with dummy variables
for Monday, Holiday, and January (for the first 5 days). The results showed that the
week-end and holiday effects are significant, but the January effect is not significant.

Interpretation or Rationale for the January Effect

There are 2 major questions on the January effect. The first question is the reasons
for the January effect. The second question is the persistence of the January effect.

As for the rationale for the January effect, there are several explanations. The
most popular hypothesis is the tax-selling hypothesis, which argues that investors sell
stocks whose prices have been falling during the year, and the capital loss can be
deducted from capital gains tax, and then in the following year, the investors can buy
back the identical or similar stocks or other entirely new stocks. However, there are
some objections to this explanation. (1) Such investment strategy is subject to the tax
laws against wash sales (see appendix note). (2) If the tax-selling hypothesis should hold
true, the January effect should be larger after World War II, when income tax rates are
higher. However, Keim (1983) found that the January effect was larger during the pre-
war period. (3) The January effect should not exist in countries where there is no capital
gains tax, or the tax year does not start in January. But, Brown, Keim, Kleidon, and
Marsh (1983) found higher returns over December January and July August in
Australia where the tax year is July 1 June 30. Also, as reviewed before, Berges,
McConnell, and Schlarbaum (1983) found the January effect in Canada for the period
1951-80, where the capital gains tax was absent until1973.

A second alternative hypothesis for the January effect is the portfolio rebalancing
or window dressing hypothesis, which states that around the year-end institutional
investors, rather than individual investors, sell losing stocks and buy winning stocks to
represent respectable portfolio holdings. However, Griffiths and White (1993) and Sias
and Starks (1997) found little support for the institutional portfolio rebalancing
hypothesis.

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A third hypothesis for the January effect is the new-year resolution hypothesis,
which states that people make new resolutions in December or January about on habits,
future plans, consumption, savings, and investments, and the plan or decision is
implemented in January, the beginning of a new year. So, people start investing in
bonds and stocks in January, and the January prices go up. If this hypothesis is true, the
January effect should be found in other countries, too, even if there are no capital gains
taxes and the tax year does not start in January.

A fourth hypothesis is, as stated in Wachtel (1942, p.186), that the unusual
demand for cash for the holiday season (Santa Claus effect) affects investors to sell the
stocks in December. To purchase gifts and to finance travel, investors may sell some
stocks and bonds. This hypothesis is consistent with the increasing sales during
December. The cash balances are supposed to be reinvested in the stock market after the
holiday season is over, and it causes the stock prices to rise.

The second question on the January effect is the persistence of the January effect.
Why do the January effect and the firm-size effect persist to exist? If market is efficient,
arbitrage activities will remove the return differentials. There are two theories to explain
the persistence of both the January effect and the firm-size effect. One is the transaction
cost theory and the other is the risk premium theory. First, Roll (1983), Stoll and
Whaley (1983) argue that the January effect for smaller firms may persist to exist because
the transaction cost is high for the small firms relative to their prices so that arbitrage
cannot remove the return differential. However, this theory would not apply to the
January effect for larger firms.

An alternative explanation is the risk premium theory. Rogalski and Tinic (1986)
estimated variance, beta, and Dimson (1979) beta for small firms whose shares are traded
infrequently for the period 1963-82 for 20 firm-sized portfolios using the market model.
They regressed the daily returns of each portfolio on the daily returns of equally weighted
market portfolio returns. They found that variance and beta are much larger in January
than in any other month, and variance and beta are much larger for the smaller firms than
for the larger firms. But why should the risk levels be higher in January than in any other
month? Why should January have higher risk? They argue that January is the beginning
of a new uncertain year, so the risk should be higher

In effect, the findings of the previous empirical studies for the January effect may
be summarized as follows:

(1) The January abnormal average return is higher than that for any other month.
(2) The January abnormal average return is larger for small firm stocks or low price
stocks than for large firms or high-price stocks.
(3) The January effect takes place over the first week of the trading days of a new year,
particularly on the first trading day.
(4) There are several hypotheses to explain the January effect, such as tax-selling,
portfolio rebalancing, new year resolution, unusual demand for cash, year-end
bonuses, investment decision making, etc.
10
(5) The January effect will not necessarily disappear even if the market may be efficient
due to trading costs, information costs, uncertainty, and differential marginal tax
rates on capital gains.

In this study, our objective is to examine the monthly patterns of the stock returns,
such as the January effect, for some Asian stock markets, such as China, Indonesia,
Korea, and Japan in comparison with the US stock market Except for Japan and the US,
the selected countries have neither the capital gains taxes nor large institutional
investment companies. So, neither the tax-selling hypothesis nor the institutional
portfolio rebalancing hypothesis will matter. However, the new-year resolution
hypothesis is not necessarily applicable since January in the contemporary Gregorian
calendar is not the same as January in the Chinese lunar calendar, and thus the new year
resolution can take place in February. That is, the new year's day in the Chinese lunar
calendar is widely celebrated in Indonesia and Korea as well as China. January in the
Chinese lunar calendar generally falls in February in the Gregorian calendar. Also, in
Asia the holiday season usually begins with the new year's day and lasts for a couple of
days.

III. Risk-Adjusted Return Measures

Before we discuss our empirical results, it may be useful to briefly review the random
walk theory and the methods of measuring risk-adjusted returns in the framework of capital asset
pricing model (CAPM). The efficient market theory can be explained using the following two
equations:

0 ) ( ) | ( ) (
, 1 , ,
= =
t i t
t
i
t
i
E R E R E (3-1)
) | ,......., ( ) ,......., (
1 , , 1 , , 1
=
t t n t t n t
R R f R R f (3-2)

Where = stock return at time t for stock i, (
t i
R
, 1 1
/ )

+
t t t t
P D P P , and
1 t
= a set of
information available at time t-1.

Equation (3-1) states that actual return on asset i is equal to its expected return
predicted at time t-1 with the given set of information. This model is often called a fair-
game model. Equation (3-2) states that the unconditional distribution of actual returns on
all assets should be equal to the conditional distribution of expected returns for a given
set of information. Equation (3-2) is called the random walk model. The difference
between the fair game model and the random walk model is that the random walk model
requires that the serial correlation between returns for any lag be zero, but the fair game
model does not require it (Fama, 1965, 1970; Copeland and Weston, 1992, pp. 346-350).

The risk-adjusted efficient market hypothesis (or the joint hypothesis of market
efficiency and the CAPM) is stated as follows:


t i t
t
i
t
i
R E R
, , ,
) | ( = (3-3)
] ) | ( [ ) | (
, , , , , t F t m t m t i F t i i
R R E R R E + = (3-4)
11
0 ) (
,
=
t i
E (3-5)

where E ) | (
,t i i
R = the expected return on stock i for period t, given its systematic
risk,
t i,
, . 0 > ) | (
,t m m
R E = the expected return on market portfolio for period t,
given its predicted systematic risk
t i,
and
t m,
are estimated systematic risk of stock i
and the market portfolio respectively for time t, estimated at time t-1 based on the set of
information,
1 t
(Copeland and Weston, 1992, pp. 350-352).

The CAPM models are often used to measure the performance of individual
portfolio returns on the risk-adjusted basis. There are 3 popular measures of risk adjusted
returns: Treynor (1965), Sharpe (1966), and Jensen (1968):

Treynor beta index =
p F p
R R / ) ( (3-6)
Sharpe total index =
p F p
R R / ) ( (3-7)
Jensen excess return: = ) (
F M P F P
R R R R (3-8)

It should be noted that the ratio
p F p
R R / ) ( is the realized risk premium per unit of
systematic risk beta using the security market line theory, and the ratio
p F p
R R / ) ( is
the realized risk premium per unit of total risk using the capital market line theory. Thus,
by adding the risk free rate to the risk premium, we obtain the risk-adjusted total
return:
p F p F
R R R R / ) ( + =
)
, if the Treynor index is used, and
p
R R =
F p F
R R / ) ( +
)
,
if the Sharpe index is used. Modigliani and Modigliani (1997) show the following risk-
adjusted return: ) ]( / )
M p F
R [(
P F
R R R + =
)
for the Sharpe index (see appendix note).

The first two measures can be modified to measure the relative performance of a
given portfolio with respect to the market portfolio (Shin, 1996):

Shin beta index =
M F M
P F P
R R
R R

/ ) (
/ ) (

(3-9)
Shin total index =
M F M
P F P
R R
R R

/ ) (
/ ) (

(3-10)

where = return on portfolio i,
P
R
P
= total risk of the portfolio, = return on the
market portfolio,
M
R
M
= total risk of the market portfolio, R = return on the risk free
portfolio,
F
M
= 1, systematic risk of the market portfolio, =
p
systematic risk of the
portfolio: if
P
< 0, the absolute value should be used. Otherwise, a negative portfolio
return with a negative beta would generate a positive performance index, which is clearly
wrong.

12
The two Shin indexes are essentially the same as the Sharpe index and the
Treynor index respectively. Since the denominators
M F M
R R / ) ( and
M F M
R R / ) (
are constants, dividing the Sharpe and Treynor indexes by the constants will not change
the portfolio ranking by the Sharpe and Treynor indexes. But the advantage of the Shin
indexes is that if the Shin index is greater than 1, it indicates that the given portfolio's
performance is better than the performance of the market portfolio over the sample period.
That is, if the indexes are greater than 1, it implies that

( > ) /
P F P
R R
M F M
R R / ) ( (3-11)
and ( > ) /
P F P
R R
M F M
R R / ) ( (3-12)

The common weakness of the beta based risk measures is that if the beta value is
not significant, unstable, extremely low, or high, the indexes can be unreliable, and the
portfolio performance can be greatly overestimated or underestimated. The systematic
risk can be unstable and unreliable, if the sample period is short or if the stock returns are
volatile independent of the market movement. Also, as stated before, if the beta value is
negative, the absolute value should be used for the above 3 beta risk-related measures:
R/beta, R-bRm, and the Shin beta index. Otherwise, when the return is negative, a
negative return divided by a negative beta value will give a positive value, and this will
clearly distort the performance of the portfolio. An advantage of the beta-based measures
is that statistical significance of beta and alpha can be tested. Jobson and Korkie (1981)
conclude that all the performance measures have shortcomings, but the Sharpe measure
appears to have a relatively small number of theoretical objections, but has no
accompanying significance test.


If the risk free rate is omitted, the above 5 indexes (Equations 3-6 to 3-10) can be
reduced to , /
P P
R
P P
R / ,
M P P
R R , ), /( ) / (
M p p
R R and ) / /( ) / (
M M P P
R R
respectively. The above indexes can be applied to individual securities as well as to
portfolios.

In effect, we are taking the January return, for instance, as the return of
a portfolio, called January portfolio, and taking the 12-month average returns as the
returns of the market portfolio. That is, we have 12 portfolios for each stock exchange,
and we will evaluate the performance of the 12 portfolios for each stock exchange by
applying the above 5 measures of risk-adjusted returns.

IV. Empirical Results

If the efficient market hypothesis holds true, the risk-adjusted monthly returns
should be randomly distributed and they should not show any periodic patterns. To test
the hypothesis, we have selected monthly data for the following stock markets: the
Standard and Poor's 500 Stocks (1971-2002), the Korea Stock Exchange (KOSPI, 1980-
2002), the Tokyo Stock Exchange (Daiwa Index, 1984-2002), the Shanghai Stock
Exchange (1991-2002), and the Jakarta Stock Exchange (1989-2002). The monthly stock
13
prices, monthly return series, and the monthly returns by year are plotted in Figures 1 ~
2 for the stocks of the 5 stock exchanges. There are some outliers in the monthly returns,
but we are unable to detect any clear monthly periodic patterns in the graphs.

The following analyses are applied to the monthly returns:
1. ANOVA and the Kruskal-Wallis test (Table 1)
2. Chi-square Test for the negative returns (Table 1)
3. t-Test for two means (Table 1)
4. Risk-adjusted returns (Table 1)
5. Regression analysis with dummy variables (Table 2)
6. Correlation analysis (Table 3)
7. Regression analysis with monthly returns (Table 4)
8. ARIMA, ARCH, ARCH-M, and GARCH models (Tables 5, 6)
9. Unit root, variance ratio, runs, and cointegration tests (Tables 7, 8, 9, 10)
10. VAR models (Table 11)
11. Autocorrelation analysis (Figure 3)
12. Spectral analysis (Figure 4)
13. International correlation and regression analyses (Tables 12 and 13)
14. Characteristics of the Asian and US stock market returns (Tables 14, 15, 16)
- Descriptive statistics, Normality, Homogeneity, and Factor Analysis
15. Evaluation of the Asian and US stock markets (Table 17)
16. The best and worst months in the 5 stock exchanges (Table 18)
17. January Barometer Effect (Table 19)

1. ANOVA and Kruskal-Wallis Test:

If stock returns are randomly distributed, the 12 monthly returns should also be
randomly distributed, and thus monthly returns should not show any seasonal patterns.
First, we use the ANOVA to test the following null hypothesis:


12 2 1
...... = = = (4-1)

where
i
= mean returns of month i. The results of ANOVA are presented in Table 1 for
the 5 stock exchanges. The F-values are extremely low, and the null hypothesis cannot
be rejected at the 5% level. The F-values are 1.27 for the SP500 stocks, 1.28 for the
Korean stocks, 0.903 for the Tokyo stocks, 0.804 for the Shanghai stocks, and 1.20 for
the Jakarta stocks.

However, ANOVA is based on the following two assumptions: (1) the population
monthly stock returns are normally distributed, and (2) the population variances of
monthly returns are all equal. If these two assumptions are not valid, ANOVA results are
not valid, and nonparametric tests, such as the Kruskal-Wallis could be used. Three tests
of normality and the Bartlett's test for homogeneity are used. The results are mixed as
summarized in Table 14 (3). First, the Jarque-Bera test rejects the normality hypothesis
for all 8 stock markets at the 5% level. The Tokyo stocks are accepted for normality at
7.3% level (the 4 groups of US stocks are regarded as 4 stock markets). Second, the
14
Lilliefors test for normality indicates that the Tokyo and Jakarta stocks are accepted for
normality at the 5% level, but the 4 groups of US stocks, Korean stocks, and Shanghai
stocks are not accepted for normality at the 5 % level. Third, the chi-square test for the
goodness of fit accepts normality for SP500, Dow-Jones, and Jakarta stocks, and rejects
normality for SP500 total return index, NASDAQ, Korea, Tokyo, and Shanghai.

The Kruskal-Wallis test, which is a nonparametric test, is equivalent to ANOVA
in terms of rank numbers. The Kruskal-Wallis H statistics are listed in Table 1. The
results are very similar to the ANOVA results. The computed H statistics are lower than
the critical values, and thus we cannot reject the null hypothesis that the population
medians of 12 monthly returns are all equal for the 8 stock exchanges.

2. Chi-Square Test for the Negative Returns:

In this section, we apply the chi-square test of goodness of fit for the frequency
distribution of negative monthly returns to see if the negative monthly returns are evenly
distributed among the 12 months. The results of the chi-square test are summarized in
Table 1 for the 8 stock exchanges. The chi-square test is carried out as follows. For the
SP 500 stocks for January, for instance, the January returns are negative 11 times over the
period of 32 years (34.38%). For the month of February, the monthly returns are
negative for 15 times (46.88%). For the month of September, the monthly returns are
negative for 20 times (62.5%), and so on. The average frequency of negative monthly
returns was 13.58 (42.44%). Based on these data, we apply the chi-square test of
goodness of fit for the observed frequencies of negative returns versus the expected
frequencies, 13.58. The null hypothesis is that the observed and expected frequencies are
equal. The calculated chi-square value is 13.31 and the critical chi-square value is 19.675
at the 5% level for DF=11. In effect, the chi-square test cannot reject the null hypothesis
that the observed and expected frequencies of monthly negative returns are equal for the
8 stock markets.

3. t-Test for the Monthly Returns

In Table 1, the monthly mean returns are calculated for each month. For the SP
500 stocks, the highest monthly mean return is 2.14% in January, and it is higher than
any other monthly return. This result is consistent with the January effect. But, the
question is whether it is statistically significant. Since the ANOVA and Kruskal-Wallis
tests were unable to reject the null hypothesis that the 12 monthly population mean
returns are equal, this time we tested the null hypothesis that the January population mean
return or any other monthly return is equal to the population mean of 12 monthly returns:
=
i
(4-2)

where =
i
population mean return of month i, and = population mean of monthly
returns.

The results for the t-test for the paired samples are summarized also in Table 1.
15
For the SP stocks, the t-value is significant for the positive January return. Similarly,
when the t-test for the paired samples was applied to each monthly return, the negative
September return was significantly different from the mean of the 12 monthly returns. In
effect, the results support the positive January effect and the negative September effect.

For the Korean stocks, the simple monthly return is the highest in January at
4.37%. However, the t-static is not significant. But, the t-statistic is significant for the
positive November return (3.61%), and the negative returns in August (-2.33%) and
September (-2.01%). But when the 1998 data (financial crisis) are excluded, the March
return is the highest at 3.57% and significant. The negative returns are significant in
August (-2%) and September (-2.1%). These results do not support the January effect in
Korea, but the positive March effect, and the negative August and September effects.

For the Tokyo stocks, the highest return is 2.91% in March, and it is significantly
different from the mean of the 12 monthly returns. The largest negative return is -1.64%
in September, and it is significantly different from the 12 month average return.

For the Jakarta stocks, the January return is the highest at 4.54 % for the overall
period, 1989-2002, but it is not significant at the 5% level. The next highest return is
4.04% in December, and it is significant. The negative return is the largest at -5.52% in
September, and it is significant. Excluding 1989 (high outlier) and 1998 data (the
aftermath year of financial crisis), the May return is the highest at 4.83%, and it is
significant. The next highest return is in December at 4.51%, and it is significant. The
negative return is the highest in September at -4.36%, and it is significant. The positive
December effect and the negative September effect are significant in both sample periods.

For the Shanghai stocks, the May return is the highest at 13.83% for the entire
sample period, 1991-2002, but it is not significant. None of the positive monthly returns
is significant. But there are 3 months of negative returns, namely July, September, and
December, and they are all significant. Excluding 1992 and 1994 (extremely high
outliers), the June return is the highest at 8.29%, but it is not significant at the 5 % level.
There are 3 months of negative returns, namely, May (-0.51%), September (-1.12%), and
December (-4.63%), but none of negative returns is significant.

4. Risk-Adjusted Returns

Thus far, we have examined simple average returns without adjusting for risk.
Now we examine the risk-adjusted returns. We have calculated 5 measures of risk-
adjusted returns: Sharpe index = (
P P
R / ), (
P P
R / ), Treynor index = (
M P P
R R ),
Jensen's excess return = R-bRm, and Shin-beta index= ), /( ) / (
M p p
R R and Shin-total
index = ( ) / /( ) /
M M M p
R R The results are presented in Table 1 for the 5 stock
markets for the selected sample periods excluding outlier years.

16
On the excess return basis (R-bRm), the highest return is 0.975% in December
for the SP 500 stocks, 2.561% in March for Korea, 2.037% in March in Tokyo, 3.879%
in December for Jakarta, and 5.013% in April for Shanghai.

On the Shin beta index basis (beta-risk adjusted index relative to the market
portfolio), the highest index is 16.611 in March for the SP500, 3.540 in March for Korea.
14.879 in April for Tokyo, 10.885 in January for Jakarta, and 2.818 in April for
Shanghai.

On the Shin total index basis (total risk-adjusted index relative to the market
portfolio), the highest index is 0.897 in December for the SP500, 1.672 in March for
Korea, 2.486 in March for Tokyo, 5.486 in December for Jakarta, and 0.754 in February
for Shanghai.

Which month has the highest risk? The results are also mixed. The largest beta is
2.18 in January for the SP500, 1.797 in November for Korea, 2.812 in March for Tokyo,
1.754 in August for Jakarta, and 2.318 in January for Shanghai. The largest total risk is
5.64 in August for the SP500, 9.840 in October for Korea, 7.650 in March for Tokyo,
12.29 in August for Jakarta, and 19.129 in January for Shanghai. The best and worst
months for the positive and negative returns on the simple return and risk-adjusted bases
are summarized in Table 18.

5. Regression Analysis with Dummy Variables

A regression method of testing the January effect is to use dummy variables as
used by Keim (1983), and others (Kato and Schallheim,1985). It takes the following
form:
(4-3) e D b a R
t
t
t t
+ + =

=
12
2

where = monthly dummy variables;
t
D =
2
D 1 for February and 0 for other months, =
dummy variable 1 for March and 0 for other months, etc., and e = the error term. The
intercept constant a is expected to represent the average January return since January is
represented by the situation when each of the 11 dummy variables is equal to 0. The
expected return for February is equal to a
3
D
2
bD + . Thus, if the coefficients of the dummy
variables are all negative, it indicates that the January return is the largest, and it is
consistent with the January effect. If the coefficient of a dummy variable is positive, it
indicates that the given month's return is greater than the January return.

The regression results with the dummy independent variables are summarized in
Table 2. For the SP500 stocks, the dummy variables have negative coefficients, and the
results are consistent with the January effect. The intercept is 2.1293 and it is highly
significant. The September dummy variable has the largest negative coefficient -3.3766,
so the September expected return is -1.2473(2.12993-3.3766). However, the adjusted R
2
=0.0150 is not significant.

17
For the Korean stocks, the coefficients of the dummy variables are all negative,
and the intercept constant is highly significant. The results, therefore, are consistent with
the January effect. However, when the 1998 data are excluded, the dummy variables for
March and November have positive signs, indicating the March and November expected
returns are higher than the January return. But none of the coefficients is significant. In
effect, the January effect is not supported for Korean stocks.

For the Tokyo stocks, the March dummy variable has a positive sign. But the
coefficients are not significant. For the Jakarta stocks, all the dummy have negative
variables, but the coefficients are not significant except for the negative signs for august
and September. For the Shanghai stocks, The dummy variables for April, May, June,
August, and November have positive signs, but none of the coefficients is significant at
the 5 % level. In effect, the regression results with dummy variables are consistent with
the January effect only for the SP 500 stocks, but the regression model is not significant
in terms of the F-value.

6. Correlation Analysis

Thus far we have examined whether there are significant differences in the
monthly returns or periodic patterns in the monthly returns. According to the random
walk hypothesis, all monthly returns should be randomly distributed and the expected
values of the monthly returns should be equal. The conventional statistical methods, such
as ANOVA and Kruskal-Wallis tests cannot reject the null hypothesis that all monthly
returns are equal. However, the t-tests of paired samples indicate that some monthly
returns are significantly higher or lower than the mean of the 12 monthly returns. But the
results tend to be inconclusive because the statistical significance is sensitive to the
sample. Exclusion of certain observations can significantly alter that mean return and
statistical significance.

Another proposition of the random walk hypothesis is that the monthly returns
should be independent of other monthly returns. To test this hypothesis, correlation
coefficients are calculated between monthly returns. The results are presented in Table 3.

First, for the SP 500 stocks, 9 correlation coefficients are significant at the 1% or
5% level. For instance, the January return is significantly correlated to the June return,
which is in turn correlated to the September return. The September return is significantly
correlated to the April, June, and July returns. The July return is highly correlated to the
October return, etc.

As for the Korean stocks, there are 8 significant correlations for the period 1980-
2002. Excluding 1998, the aftermath year of the 1997 financial crisis, 5 monthly returns
are significant. February and October returns are significant for both sample periods.

For the Tokyo stocks, there are 8 significant correlations for the period 1984-2002.
For China, there are 7 significant correlations for the period 1991-2002, and 13
significant correlations, if 1992 and 1994 are excluded. The January return is correlated
18
to March, April, May, and November. For the Jakarta stocks, there are only 2 significant
correlations for the period 1989-2002, and 3 significant correlations, if 1998 data is
excluded.

The above correlation results do not support the random walk hypothesis, strictly
speaking. However, the conclusion is tentative for two reasons: First, the correlation
coefficients are highly unstable, particularly in the Asian stock markets. Second, the
correlation can be spurious.

Fama and Blume (1966) selected the Dow-Jones 30 Industrial stocks, and they
regressed today's return on each of the 5 lagged return variables and found significant
correlation coefficients for the 30 stocks, but the coefficients of determination were very
low, less than 0.123. There are many correlation studies on the other stock markets, such
as Norway, Sweden, Australia, UK, and Greece. The largest correlation coefficient was
0.134 for these countries (Granger, 1968; Elton et al., 2003). We will also test regression
analysis and ARIMA models using the lagged variables in the next sections.

7. Regression Analysis with the Monthly Returns

To examine if the monthly returns are correlated to the past 12 monthly returns,
we test the following regression model:


t t t t t t t t t t
u R a R a R a R a a R + + + + + + =
12 12 3 3 2 2 1 1 0
...... (4-4)

where = the monthly returns for the preceding 12 months.
12 1
,....,
t t
R R

In the above function (4-3), the January monthly return, for instance, is a function
of the preceding 12 monthly returns. The regression results are summarized in Table 4
for the SP500 stocks, the Korean stocks, and the Tokyo stocks. Since the sample period
was too short, the regression model was not tested for the Shanghai and Jakarta stocks.

First, for the US stocks, the following monthly returns have at least one
significant variable (t-value at the 5% level): January, March, April, and August. For
example, this year's January return is significantly correlated to last year's April return.
The March return is significantly correlated to last year's March return, and last year's
July and August returns. The August return is significantly correlated to last year's
October return.

Next, for the Korean stocks, the April return is significantly correlated to last
year's returns of January, February, March, April, May, June, July, and September. The
adjusted R
2
is 0.7348. The July return is significantly correlated to last year's February
return. The August return is significantly correlated to last year's July and August returns.
For the Tokyo stocks, the February return is significantly correlated to last year's
February return. The May return is significantly correlated to last year's July return.

8. ARIMA, ARCH, ARCH-M, and GARCH Models
19

A time series model with a single dependent variable can be expressed by the
following ARIMA (autoregressive integrated moving average) model:


q t q t t t p t p t t t
e e e e y y y y

+ + + + = ... ..
2 2 1 1 0 2 2 1 1 0
(4-5)

where are the autoregressive terms, and are the white noise error series. It states
that dependent variable is a function of lagged dependent variables and error series.
i t
y
i t
e

t
y

A random walk series can be expressed by an ARIMA model, ARIMA (1,0,0):

(4-6)
t t t
e y y + =
1
or
t t t
e y y + + =
1
(4-7)

where = a constant or drift term. Equations (4-6) and (4-7) are estimated in arithmetic
values and natural logarithms.

The ARIMA models were tested for the 5 stock exchanges. The results are
summarized in Table 5. For the SP 500 stocks, the adjusted R
2
values are high and the
coefficients of the MA term are close to 1.0 for all equations, with and without the
drift term, in logarithms and arithmetic values. But the highest adjusted R
1 t
y
2
values are
obtained for the log models: 0.9975 for the log models with and without the drift term.
The Q statistics indicate that residual series are white noise for all models. It implies that
the ARIMA models are appropriate and the residual series have no significant periodic
patterns.

For the Korean stocks, the highest adjusted R
2
(0.9881) is obtained for the log
model with a drift term. The Q statistics indicate that the residual series are white noise
for the two log models, but not for the two non-log models. Similarly, the log model with
a drift term is the best for the Tokyo stocks (0.9603) and the Shanghai stocks (0.9420).
For the Shanghai stocks, the Q statistics indicate that the residual series for the non-log
models are white noise, but the residual series are not white noise for the log models.
For the Jakarta stocks, the adjusted R
2
is the highest at 0.8705 for the model in arithmetic
values with a drift term. The Q statistics indicate that the residual series are white noise
for all 4 models. These results strongly support the random walk hypothesis for all 5
stock exchanges.

For the monthly return series, various ARIMA models were tested, such as
ARIMA(12, 0, 0 ), ARIMA (12,0,12), and ARIMA (12, 1, 12). The results for ARIMA
(12, 0, 0) are presented in Table 4. The adjusted R
2
values are negative for the SP500,
Korea, Tokyo, and Jakarta stocks, except for the Shanghai stocks. For the SP500, Korea,
and Tokyo stocks, none of lagged variables is significant. But for the Jakarta and
Shanghai stocks, there are one and two significant variables respectively. The Q statistics
indicate that the residuals are not white noise for the SP500, Korea, Jakarta, and
Shanghai stocks. But the residuals are white noise for the Tokyo stocks. In effect, the
20
ARIMA models tend to support the random walk hypothesis for the 5 stock exchanges
(see appendix note).

In Table 6, heteroscedasticity is tested in AR(1) with ARCH, ARCH-M and
GARCH models. For the ARCH(m) model, the mean and variance equations are given
below:

(4-8)
t j t j t
p
j
t
u x y + + =

=

1
0
h (4-9)
2
1
0
2
j t
m
j
j t t
u

=

+ = =

where is the variance conditional on the past.
t
h

The mean and variance equations for the ARCH-in-Mean or ARCH-M (m) are
given by

(4-10)
t t j t j
p
j
t
u h g x y + + + =

=

) (
1
0


t t t
v h = u , or u
t t
h log = (4-11)
h (4-12)
2
0 j t
m
j t
j t t
u

+ =

The mean and variance equations for the GARCH (p, q) model are given by



=

+
=
+ + + =
r
j
j t j t j t j t
m
j
t
u u x y
1 1
0
(4-13)

t t t
v h = u , or u (4-14)
t t
h log =
h +
2
1
0 j t
q
j
j t
u

=

+ =
j t
p
j
j
h

=

1
(4-15)


(4-16) 1
1 1
< +
= =
q
j
p
j
j j


In addition to the above models, there are other specifications, such as integrated
GARCH, Exponential GARCH (EGARCH), and nonlinear ARCH, and multivariate
GARCH (Hamilton, 1994, pp. 657-676)

The monthly return is calculated as the first difference in log monthly stock price
indexes, r
t
= ln ; u = the error term, and = error variance. In Table 6, we
note the following results. For SP500, SP500 total return index, and NASDAQ stocks,
there are some significant alpha coefficients in the variance equations for the ARCH
model or GARCH model. For the Dow-Jones stocks, the variance equation is not
significant. There are also significant alpha coefficients for the Korean and Shanghai
stocks in the GARCH models, but there are no significant alpha coefficients in the
variance equation for Tokyo and Jakarta markets. However, when the Lagrange
multiplier method was used, heteroscedasticity was not significant for all 8 stock markets
in spite of extreme outliers in the Asian stock markets.
1
ln

t t
p p
t
2
t

21

9. Unit Root, Variance Ratio, Runs, and Cointegration Tests

For the monthly stock prices, unit root and cointegration tests were applied.
Before we present the test results, it may be useful to briefly review the meaning and
methodology of such tests in interpreting the test results. Economic time series data can
be divided into two types: stationary time series and non-stationary time series (unit root,
random walk). Non-stationary time series can be divided into the following three types:
(1) simple random walk with no constant and no trend, (2) random walk with a constant
(drift), and (3) random walk with a constant and around a stochastic trend:

(4-17)
t t t
e y y + =
1

t t t
e y y + + =
0 1
(4-18)

t t t
e t y y + + + =
1 0 1
(4-19)

Two tests are most widely used to test the unit root process: the augmented
Dickey-Fuller test and the Phillips-Perron test. For the Dickey-Fuller test, the following
two test regression equations are used: one with a constant and no trend, and the other
with a constant and trend.

(4-20)
t j t
p
j
j t t
Y Y Y + + + =

=

1
1 1 0

t j t
p
j
j t t
Y t Y Y + + + + =

=

1
2 1 1 0
(4-21)

where Y = stock price index,
0
= constant, and t = trend. The null hypothesis is that
1
= 0 for the unit root process. If , 0 < we would accept the alternative hypothesis that
the series is stationary series. The lag- terms
j t
Y

are added to correct the problem of

serial correlation in the regression equations. In the Phillips-Perron test, a non-parametric
correction method , i.e., the Newey-West method, is used to estimate the error variance to
correct the problem of serial correlation in the error terms..

The statistical results of the Dickey-Fuller and Phillips-Perron tests are
summarized in Table 7 for the 8 stock markets. We note that the results vary with the test
methods. For instance, the computed test statistic is -1.091 for the SP 500 stocks for the
constant and no trend model and the critical value is -2.57. The test statistic is -1.32 for
the constant and trend model and the critical t value is -3.13 at the 10% level. Since the
computed test statistic exceeds the critical value, we accept the null hypothesis of unit
root. For the Korean stocks, the test statistic is -2.6395 for the model with constant and
no trend, and the critical value is -2.57. Thus we reject the null hypothesis of unit root for
the model. However, we note that for the model with a constant and trend, the test
statistic is -2.2821 and the critical value is -3.13. Thus we accept the null hypothesis of
unit root. Similarly, the test statistics indicate that the stock prices are of the unit root for
all 5 stock price indexes.

22
If two non-stationary variables are used to calculate regression and correlation
coefficients, the correlation can be spurious. There are two remedies. First, differenced
values can be used if the variables are difference-stationary. Second, if the two non-
stationary time series are cointegrated, the level-variables can be used for regression. If
two times series are cointegrated, it implies that the two times series have a long-run
equilibrium relationship.

To see if the 8 stock market prices have long-run equilibrium relationships, we
have also applied the Dickey-Fuller test, Phillips-Perron test, and the Johansen test. In
the Dickey-Fuller test of cointegration, two types of cointegration regression equations
are first calculated, as shown by equations (4-22) and (4-23).

(4-22)
t j t
M
j
j t
u X Y + + =

=
,
1
0

(4-23)
t j t
M
j
j t
u X t Y + + + =

=
,
1
1 0


. where X is taken as the independent variable, M = the number of independent variables.
Then the residuals are tested by the unit root test procedure:

(4-24)
t i t
p
t
i t t t
v u u u + + =

=

1
1


where = 1 is the null hypothesis that the error series is unit root (non-stationarity)

The difference between the Dickey-Fuller method and the Phillips-Perron method
is concerned with the correction method of serial correction, as mentioned before. If the
residual series is not unit root, we accept that the residual series is stationary, and we
accept the alternative hypothesis that the two variables are cointegrated. If the two
variables are not cointegrated, differenced variables should be used for regression
analysis to avoid spurious correlation. However, if the two variables are cointegrated, the
level variables can be used for regression analysis without the problem of spurious
correlation.

The results for the variance ratio test are summarized in Table 8. The z-scores
indicate that we cannot reject the null hypothesis of the random walk. For q=30, the high
z-scores indicate that there are some outliers (see appendix note).

The runs tests for randomness were applied for the mean and median values for
the overall sample periods (Table 9). The results support randomness for the 5 stock
markets for the median values. But the runs tests for the mean values support for the 4
stock exchanges except for the Korean stocks. When the runs test is applied to monthly
returns for each month, the random walk hypothesis is supported for the 5 stock markets

The cointegration test results for the pairs of the 8 stock market monthly stock
prices are summarized in Table 10. The Dickey-Fuller test indicates no cointegration, but
the Phillips-Perron test indicates that SP500 stocks are cointegrated with Korean and
23
Tokyo stocks. When the Johansen test (Johansen, 1988, Johansen and Juselius, 1990),
which uses the maximum likelihood estimation method for cointegrating vectors, is
applied, the results indicate that only SP500 and NASDAQ are cointegrated, and all other
stock markets are not cointegrated.

10. VAR Models

To examine if there are independent relationships among the stock markets, the
following VAR models are applied to the monthly returns and monthly stock prices in the
5 stock exchanges:

Y
1 1 2 1 1 0
... u Z Y
t t t
+ + + + =

(4-25)
Z
2 1 2 1 1 0
... u Z Y
t t t
+ + + + =

(4-25)

where Y , . , = monthly stock price indexes or monthly returns of the 5 stock
exchanges. The results are presented in Table 11. For the monthly returns, there are no
significant variables in each equation at the 5% level. Only for the SP500, the lagged
Jakarta is significant at the 5.49%. For the monthly prices, in all equations, its own
lagged stock price is significant. But for the SP500 stock prices, the lagged Jakarta and
lagged Shanghai are significant. When tested without the Shanghai stocks, the results
were very similar as to the significance of the variables in each equation.
t t
Z

11. Autocorrelation Analysis

Autocorrelation coefficients are calculated for the 5 stock price indexes to test if
the stock market price indexes are random walks. The autocorrelation function is given
by

2
1
1
) (
) )( (
) (
y y
y y y y
k y
n
t
t
k t
n
k t
t

+ =
(4-27)

where y(k) = autocorrelation coefficient at time lag k for the time series data, i.e.,
monthly stock prices or monthly returns. The test statistic Q is distributed as a chi-square
distribution with k-c degrees of freedom, where c = the number of autocorrelation
coefficients, k = selected lag length in the autocorrelation function. It is used to test the
null hypothesis that the time series is white noise (mean is zero and variance is constant) ,
using the critical values of a chi-square distribution. If the Q statistic is less than the
critical chi-square statistic, we would accept the null hypothesis that the autocorrelation
functions (ACFs) are white noise and do not show any patterns..

The graphs of autocorrelation coefficients against time lags (correlograms) are
presented in Figure 3 for the monthly prices and monthly returns. If the stock price series
is a random walk series, the autocorrelation coefficients are expected to be high over the
shorter time lags and gradually decline. We note that the autocorrelation functions
exactly follow the patterns of random walks for the 5 stock price indexes. On the other
24
hand, the autocorrelation functions of the monthly returns are not significant in all 5
series. The Q statistics indicate that the monthly return series are white noise These
results are consistent with the random walk hypothesis (see appendix note).

12. Spectral Analysis

The objective of spectrum analysis is to decompose the original time series into
sine and cosine function of different frequencies. It is based on Joseph Fourier's idea
(1822) that any periodical time series can be expressed in terms of one or more sine
curves of different frequencies. The Fourier analysis is to find optimal coefficients in the
following finite Fourier function:


t f
k
f
f t
e
N
ft
N
ft
y + + + =

=
] 2 ) sin( 2 ) cos( [
2
1
0

(4-28).

If the or coefficient is large and significant, it indicates a strong periodicity at the given
frequency. The coefficients and are converted to amplitude and phase angles for each
frequency. The periodogram is defined by

(4-29) 2 / ) (
2 2
f f f
N P + =

where = periodogram (periodogram value) at frequency f, and N = total number of
observations.
f
P

A periodogram plots line spectra (a set of amplitudes) corresponding to all
frequencies. By examining the periodogram, we can determine if a series is a random
walk series or if it contains periodicity, such as cycles and seasons. A spike in the line
spectrum indicates periodicity. If a series is a linear trend series, the periodogram would
show a flat line. If a series is a random walk series, the periodogram would show spikes
of roughly equal size spread throughout the spectrum.

As reviewed previously, spectral analysis was used by Granger and Morgenstern
(1963, 1970, pp. 103-131), and they did not find any significant seasonal or periodical
patterns in the various stock prices for the periods 1871-1956 and 1918-64. In their
analysis, they used logarithmic first differences for the following reasons: First, the
transformed data have more symmetric and more nearly normal histograms. Second, if
the random walk hypothesis is correct, the logarithmic first differences are a well-
behaved variable whereas the levels are not.

Using their methodology, we applied spectral analysis to the first differences in
the log prices for the 5 stock price indexes. The spectral diagrams (periodograms) are
presented in Figure 4. For the purpose of comparison, hypothetical data are used to show
periodograms for cyclical data, and they are shown in the last 2 panels of Figure 4. That
is, when cycles are present in a time series, spikes are expected to show up in the
25
periodograms. In effect, the periodograms do not reveal any significant spikes to indicate
seasonal or periodical patterns in the Asian and US stock markets (see appendix note).

13. International Correlation Analysis

Extending the random walk theory to the international stock markets, two
propositions are possible: First, if the market is efficient, information in one stock market
should be available in another stock market instantaneously, and thus stock market
returns should be highly correlated. Second, according to the random walk hypothesis,
yesterday's stock returns should not be correlated to today's stock returns, and today's
stock returns cannot be used tomorrow's stock returns. Since there are time differences
between the US stock markets and the Asian markets, if the two stock markets are
correlated, it would contradict the random walk hypothesis.

Reilly and Wright (represented in Reilly and Brown, 2003, p.94) calculated
correlation coefficients between the SP 500 stocks and other capital market assets using
the monthly data for the period 1980-1999. They found that the SP 500 stocks have high
correlation with the Toronto stocks (0.769), the London Stock Exchange (0.641), and the
Frankfurt Stock Exchange (0.518), and low correlations with the Tokyo Stock Exchange
(0.306).

In our study, the correlation coefficients are calculated for the 5 countries for the
period 1991-2002, and for the 4 countries excluding the Shanghai stocks for the period
1989-2002. The correlation coefficients are significant between monthly returns for the 4
stock exchanges, namely, SP500, Korea, Tokyo, and Jakarta, but the Shanghai stocks are
not correlated to the other stock market returns (See Table 12).

Next, correlation coefficients were calculated for the 5 stock exchanges by month
for the period 1991-2002. The Shanghai stocks did not also show any significant
correlation with other stock exchanges. So, omitting the Shanghai stocks, the correlation
coefficients were recalculated for the 4 countries for the period 1989-2002. The results
are presented in Table 7. It is interesting to note that the 4 stock returns are not always
correlated. For instance, the Korean stocks are correlated to the Jakarta stocks only in
January and April.

The US stocks are correlated to Jakarta stocks only in March. The US stocks are
correlated to the Tokyo stocks only in May, June, and August. It is interesting to note that
the Korean stocks are not correlated to the SP500 stocks in any month, though the
correlation coefficient is significant for the overall period (0.278). The Korean stocks are
correlated to the Tokyo stocks in February, April, May, June, July, and August.

The Tokyo stocks are correlated to the US stocks in May, June, and August. The
Tokyo stocks are, as stated before, significantly correlated to the Korean stocks in
February, April, May, June, July, and August. The Jakarta stocks are correlated to the
Korean stocks in January and April. The Jakarta stocks are also correlated to the SP 500
26
stocks only in March. But the Jakarta stocks are not correlated to the Tokyo stocks in any
month.

Simple and multiple regression equations are calculated for monthly stock prices
in logarithms for the 5 stock exchanges. The results are presented in Table 13. First, as
for the simple regression results, we note the following. (1) The SP500 stock price index
is significantly correlated with other 4 stock prices indexes. (2) The Korean stock price
index is also significantly correlated with other 4 stock price indexes. (3) The Tokyo
stock price index is significantly correlated with the SP500, Korea, and Shanghai stock
price indexes, except for the Jakarta stock price indexes. (4) The Jakarta stock price index
is correlated with the Korea, SP500, and Shanghai stock prices indexes, except for the
Tokyo stock price index. (5) The Shanghai stock price index is significantly correlated
with other 4 stock exchange price indexes. As for the multiple regression results, we note
the following. (1) For the SP500 stock price index, the Tokyo and Korean stock price
indexes are significant. (2) For the Korean stock price index, 3 stock exchange indexes
are significant except for the Shanghai index. (3) For the Jakarta stock price index, 3
stock exchange price indexes are significant except for the SP500 index. (4) For the
Shanghai stock price index, the Tokyo and Jakarta stock price indexes are significant, but
the Korean index and SP500 indexes are not significant. However, these statistical results
are subject to estimation problems since the data contain extreme outliers and the low
DW statistics indicate significant serial correlations.

14. Characteristics of the 5 Stock Markets

Some descriptive statistics and other characteristics of the Asian stock markets are
Summarized in Table 14. The sample period varies with the stock market due to
availability of data. Over the available sample period, the Shanghai stocks have the
highest average monthly return at 3.2841 % during the 12 years (1991-2002). The next
highest average monthly return is for the Korean stocks, with the average monthly return
of 1.009% over the 23 years (1980-2002). The next follows the SP500 stocks (0.68%),
and the Jakarta stocks (0.6683%). The Tokyo stocks have the lowest monthly average
return (0.3554%) for the period 1984-2002.

The total risk is the largest at 22.3845% for the Shanghai stocks, corresponding
to the highest average return. But the next highest total risk values are the Jakarta stocks
(9.81%) and the Korean stocks (8.91%). The total risk values are 8.91% and 22.38%
respectively. Their total risk values are higher than the SP 500 stocks (4.52%), but the
Tokyo and Jakarta stocks have lower returns and higher risk values (5.92% and 9.80%)
than the SP 500 stocks. The risk-return relationship does not necessarily hold true for the
5 stock exchanges. Systematic risk will be discussed in the next section.

As for the median values of monthly returns, the SP 500 stocks have the highest
median return 0.805%, and the next highest values are Shanghai (0.4634%), Tokyo
(0.15%), Jakarta (-0.16 %), and Korea (-0.285%). Also, in this case, the return-risk
relationship does not hold true.

27
Next, we have applied the chi-square test and Lilliefors test for the null hypothesis
that monthly returns are normally distributed. The chi-square test supports normality for
the Tokyo stock returns, and the Lilliefors test supports both Tokyo and Jakarta stock
returns for normality, but normality hypothesis is not supported for the SP 500, Korea,
and Shanghai stocks.

To see if the 5 stock exchanges can be grouped into similar groups, factor analysis
was applied. The results are summarized in Table 15. When 5 factors are specified, the
results show that 2 factors are significant. When 4 factors are specified, the Tokyo and
Korean stocks are grouped to the common factor. The Jakarta stocks, SP500, and the
Shanghai stocks are grouped independently. When 3 factors are specified, Tokyo, SP500,
and the Korean stocks are grouped to the common factor, and Jakarta and Shanghai are
independent. Finally, when two factors are specified, Korea, SP500, Tokyo, and Jakarta
belong to the common factor and Shanghai is independent. In Table 16, the correlation
coefficient matrixes are presented. The correlation coefficients of the monthly stock
prices for the period 1989-2002 are all significantly correlated for the 8 stock markets.
The correlation coefficients of the monthly returns, however, are also significantly
correlated for the 7 stock markets except for the Shanghai stocks.

15. Evaluation of the Asian and US Stock Returns

In this section, we compare the performance of the Asian and US market stock
returns. The results are summarized in Table 17. As we have reviewed before, the simple
average monthly return is the highest at 2.038% in Shanghai, and the next highest returns
are 0.853% in Korea, 0.623% in Jakarta, and 0.695% for the SP 500, and 0.31% in Tokyo.
However, when the analysis of variance is applied, the F-test cannot reject the equality of
population means (F=0.958). Also, the Kruskal-Wallis H test cannot reject the equality of
population medians (H=3.244). The t-test for paired samples is applied for the monthly
mean return series of individual stock exchanges. The results show that only the mean of
the Tokyo return series is significantly lower than the mean of the average series of the 5
stock exchanges.

The total risk (standard deviation) is calculated from the 12 monthly returns over
the sample period for each exchange. The total risk is the highest in the order of
Shanghai, Jakarta, Korea, Tokyo, and SP500. The systematic risk beta is obtained by
regressing the monthly return series of each stock exchange on the average monthly
return series of the 5 stock exchanges. The systematic risk is the highest at 1.7496 for
Shanghai, and the next highest beta values are 1.1336 for Jakarta, 0.9085 for Korea,
0.7095 for Tokyo, and 0.50 for SP 500. The total risk ranking and the systematic
ranking are consistent.

In terms of the CAPM- adjusted excess returns (R - R
m
), Shanghai has the
highest excess return at 0.333%, and the next highest excess returns are 0.2427% for
SP500, 0.0323% for Korea, -0.3280 for Tokyo, and -0.40185 for Jakarta. On the
Return/beta and the Shin beta index bases, the SP 500 stocks are the best (1.389, 1.544),
the next best stock markets are Shanghai (1.165, 1.294), Korea (0.939, 1.043), Jakarta
28
(0.549, 0.380) and Tokyo (0.439, 0.372). On the Return/std. and the Shin total index
bases, the SP500 is again the best (0.771, 1.209). The next best markets are Shanghai
(0.538, 0.842), Korea (0.468, 0.732), Jakarta (0.53, 0.380), and Tokyo (0.238, 0.372).
In effect, on the risk-adjusted bases, the SP 500 stocks showed the best performance
during the sample period, but it is not surprising because the SP 500 stocks are a selection
of the best leading corporations in the leading industries in the United Sates. Another
reason is that the US stock market was booming during the 1990s until January 2000.

16. The Best and Worst Months

As we have examined before, the best and worst months varied with the risk-
adjusted return measures. For the SP 500 stocks for the period 1971-2002, the positive
January effect and the negative September effect are significant. For the Korean stocks
for the period 1980-2002, excluding 1998, the positive March effect and negative August
and September effect are significant. For the Tokyo stocks for the period 1984-2002, the
positive March effect and negative September effect are significant. For the Shanghai
stocks for the period 1991-2002, excluding 1992 and 1994, only the negative November
effect is significant. For the Jakarta stocks, the positive May and December effect, and
negative August and September effect are significant. As for the risk-adjusted returns, the
results vary with the risk-adjustment measures, as shown in Table 18. For the SP 500
stocks, January concedes to March and December. It is interesting to note that
December can be good for the SP 500 stocks, but bad for the Shanghai stocks. For the
negative returns, all 5 measures point to December as a bad month for the stocks.

These results do not support any of the three hypotheses to explain the January
effect since there is no January effect in the Asian stock markets. However, it is
interesting to note that the monthly returns tend to be higher in the springtime in the
Asian stock markets: Korea (March), Tokyo (March), Jakarta (May), and Shanghai (June).
As for the negative returns, September is a bad month for the SP 500 stocks, Korea, and
Tokyo. The bad month is August for Jakarta and it is December for Shanghai. Why the
springtime effect in Asia? As briefly mentioned before, the new school year starts in
March in Korea, and in April in Japan. The new year in Chinese lunar calendar begins in
February in the Gregorian calendar.

17. The January Barometer Theory

The January effect discussed in this paper should not be confused with the
January effect of version 2, which is often called the January predictive hypothesis or the
January barometer theory. The January barometer theory states that the January return is
a predictor of the stock market conditions of the rest of the year. That is, if the January
return is high, the stock returns for the rest of the year should be also good. Bloch and
Pupp (1983) used the SP500 stock indexes for the period 1950-82. They calculated 12
regression equations for the months January to December, with 3 independent variables:
the January return, the January return-squared, and the time trend. They conclude that the
January return is not significant in predicting the next 12 month stock returns. To test the
January barometer theory, we test the following simple regression equations for the
29
Asian and US stock market monthly returns:
i i i i
x y + = , where x = the January return.
For the dependent variable, we have tested two types of average returns: = the average
of monthly returns, January to December, and y = the average of monthly returns,
February to December, excluding the January return of the year. The regression results
are summarized in Table 19. When the dependent variable is y , the January return is
significant for the 4 US stock markets, Korea and Tokyo stock markets. But, it is not
significant for Jakarta and Shanghai stock markets. The significance is largely due to the
fact that the dependent variable, i.e., the average of the 12 monthly returns, includes the
independent variable, i.e., the January return (built-in effect)
1
y
2
1

When the dependent variable is
2
y
,
the average of the 11 monthly returns,

excluding the January return, the independent variable, i.e., the January return, is
significant at the 5% level only for the SP500 total index returns. It is not significant for
all other stock markets, namely, the SP500, Dow-Jones, NASDAQ, and the 4 Asian stock
markets. These results generally support the Bloch-Pupp conclusion that the January
return is statistically not significant in predicting the average return for the next 11
months.

IV. Summary and Conclusions

We have applied various statistical analyses to the monthly returns of the 5 stock
exchanges to find if there exist monthly or periodic patterns, such as the January effect
that contradict the random walk theory. We have applied ANOVA, the Kruskal-Wallis
test, the chi-square test, the runs test, etc. These tests showed that we cannot reject the
null hypothesis that the population monthly returns are all equal. Also, we have applied
regression analysis, autocorrelation analysis, and the VAR models. These results tended
to support the random walk theory in the sense the coefficients were mostly not
significant or the R
2
values were extremely low. The unit root test and ARIMA (1,0,0)
model strongly supported the random walk theory. The results of other ARIMA models
and autoregression analysis were consistent with the random walk theory. The spectral
analysis did not show significant periodical patterns. These results are also consistent
with the random walk theory.


Correlation analysis is applied to the monthly returns of the 5 stock exchanges for
the period 1991-2002. The results show that the SP500 stocks, Tokyo stocks, Korean
stocks, and the Jakarta stocks are significantly correlated. The Shanghai stocks are not
correlated to any other stock markets. When the correlation coefficients are calculated by
month, the correlation coefficients are significant only for some months and not for all
months. For instance, the Korean stocks are correlated to the Tokyo stocks only for the
months of February, April, May, June, July, and August. The Korean stocks are not
correlated to the SP 500 stocks in any month. The Tokyo stocks are correlated to the SP
500 stocks only in May, June, and August. The Jakarta stocks are correlated to the
Korean stocks only in January and April. The Shanghai stocks are not correlated to any
other stock markets.
30

Thus far we have examined the stock market behavior in the Asian and US stock
markets. There are three interesting questions to be briefly discussed. First, do the March
and September effects, for instance, imply that if investors buy SP500 stocks, Korean
stocks, Tokyo stocks, and Jakarta stocks in September 30 (or the last trading day of the
month) and sell in March (or the last trading day of the month), they will make the largest
risk-adjusted excess returns? Should the investors in Shanghai buy stock indexes in
December (or the last trading day of the month), and sell in April or June? The second
question is, do these March and September effects or the June, April and December
effects contradict the random walk theory? The third question is, why do I make this
secret information publicly available instead of using it for private gain?

Since the above three questions are all related, they can be answered as follows.
First, if the market is efficient, the information on the March and September effects
should travel fast and arbitrage activities are supposed to wipe out the opportunities for
the excess risk-adjusted returns. However, if investors do not know the information, or if
they do not get the information simultaneously, or if they do not trust the information to
use it, some investors who use the information may be able to make excess returns.
Second, the March and September effects are concerned with the expected returns. That
is, a March return can be lower or negative for a year, but it can be higher in another year.
But the average return should be higher over a long period of time. Thus, using the above
trading rule does not guarantee that investors will make the highest excess returns every
year. Third, the excess risk-adjusted return is really a gross return in the sense that trading
cost, information cost (research cost and the price to pay for the information), and taxes
are not yet subtracted. Thus, if these costs are subtracted, the excess return may disappear.
Fourth, this study is concerned with aggregate market indexes. If investors wish to select
a number of specific stocks, they will incur selection cost. Fifth, in this paper, we have
considered only two types of risk in measuring risk-adjusted returns, namely, systematic
risk beta and standard deviation as total risk. However, there may be other types of risk,
such as liquidity risk, reliability risk (risk of believing false information), etc. If these
factors are included in a broad measure of risk, the true risk-adjusted return can be lower
than the conventional risk-adjusted return.

Finally, the following points may be noted. First, our study is a macro analysis in
that we dealt with the aggregate stock market indexes instead of individual firm's stock
prices or portfolio returns. Also, in this study we have used monthly data. Therefore, this
paper does not deal with the January effect found over the first week of a new year for
individual small firm-stocks or portfolios. Second, the stock returns in this study are
calculated based on the closing price of the last trading day for each month. It is possible
that the results could be different if the price at the beginning of the month or at the
middle of the month, monthly average price, or daily average price is used. Third, the
systematic risk beta values are highly unreliable since they are often statistically not
significant and sometimes negative. The standard deviation as a measure of total risk is
better in the sense that it cannot be negative and its statistical significance does not matter.
Fourth, except for the Tokyo stocks and the SP500 total return index, the stock returns
do not include dividend payments for Korea, Shanghai, and Jakarta stocks. Stock returns
31
with dividend payments can bring different results. Fifth, it may provide useful
information if we examine other Asian stock markets not examined in this paper, such as
Thailand, Hong Kong, Taiwan, and the Philippines.

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