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E. Common Errors of Empirical Studies


3) 4)

6) 7) 8)

Biased model of equilibrium returns Specification searches Sample selection bias Survivorship bias Biased measures of return Inappropriate portfolio weightings Failure to distinguish between statistical and economic significance Overestimating the frequency of opportunities for arbitrage

F. Semistrong-Form Anomalies: Long Term

New Issues (IPOs) II. Stock Splits III. The Value Line Investor Survey IV. Self- Tenders and Share Repurchase

New Issues (IPOs)

Loughran and Ritter (1995) studies of long-run

returns report that IPOd equities underperform benchmark portfolios by approximately 30% over the five-year period. They do not use a CAPM risk adjustment but they control for size which is a variable that easier to measure and correlated with beta. If valid, this result would imply the market is in efficient in its semistrong form.

Ibbotson (1975) studies of short-term returns which

provide several possible explanations of the short-term underpricing of IPOs. Portfolios of new issues with identical seasoning were formed by Ibbotson. Using the empirical market line he was able to estimate abnormal performance indices in the month of initial issues and in the after market.

The estimated systematic risk (beta) in the month of issue

was 2.26, and the abnormal return was estimated to be 11.4%. This will represents a statistically significant positive abnormal return. Ibbotson concludes that the evidence cannot allow us to reject the null hypothesis that aftermarket are efficient.

Figure 11.7

Figure 11.8

Stock Splits
Fama, Fisher, Jensen, and Roll (1969) use the

monthly data for an interval of 60 months around the split ex date for 940 splits between January 1927 and December 1959. Figure 11.9 plots the cumulative average return for the stock split sample. Positive abnormal returns are observed before the split but not afterwards. The split can cause the abnormal returns but it has no economic logic to it.

The hypothesis of the study indicate that stock splits

might be interpreted by investors as a message about future changes in the firms expected cash flow. To test this hypothesis the sample was divided into those firm that increased their dividend beyond the average for the market in the interval following the split and those that paid out lower dividends. The results (Fig 11.10) reveal that stocks in the dividend have slightly positive returns following the split.

Figure 11.10

The Value Line Investor Survey


Value Line predictions represent a clear attempt to

use historical data in complex computerized filter rule to try to predict future performance. Black (1971) perform the first systematic study utilizing Jensens abnormal performance measure in Eq. (11.7). Blacks indicate statistically abnormal performance for equally waited portfolios formed from stocks ranked 1,2,4 and 5 by Value Line and rebalanced monthly.

Copeland and Mayers (1982) and Chen, Copeland,

and Mayers (1987) measured Value Line portfolio performance by using a future benchmark technique that avoids selection bias problems associated with using historic benchmarks as well as the known difficulties of using CAPM model benchmarks. They find considerably less abnormal performance than Black. Where Black reported (roughly) 20% per year for an investor.

Self-Tenders and Share Repurchases

Lakonishok and Vermaelen (1990), and Mitchell and

Stafford (1997) find abnormal returns from a trading rule where want purchases a stock on the day following the announcement of a planned self-tender or open-market repurchase plan. For Example, Mitchell and Stafford report three-year buy-and-hold returns of 9% for 475 self-tenders during the 1960-1993 time period, after controlling for size and for book-to-market. This abnormal returns are statistically and economically significant and would be consistent with market efficiency.

G. Semistrong-Form Anomalies: Short Term

Mutual Funds II. Dual-Purpose Funds III. Timing Strategies IV. Stock that Over- or Undershoot

Mutual Funds
They can provide 2 types of services to their

clients: 1) Minimize the amount of unsystematic risk an investor must face, through efficient diversification in the face of transaction cost. 2) Able to use their professional expertise to earn abnormal returns through successful prediction of security prices.

Various performance measure:

Sharpe ratio :

Rjt Rft j
Treynor index :

Rjt Rft j Abnormal performance : jt = (Rjt Rft)- [j (Rmt Rft)]

Dual-Purpose Funds
Company whose only assets are the security of

other companies. Were established on the premise that some investors may wish to earn a security providing only income, whereas their investors may desire only potential capital gains.

Timing Strategies
Timing would be possible if the market or segments of it

were to overreact or under react to the arrival of new information.

Graham and Harvey (1996) and Copeland & Copeland

(1999),examine trading rules designed to exploit new information about volatility.

Copeland & Copeland find that when an index of

forward-looking implied volatility ,called VIX, increases unexpectedly from its current level.

Stock that Over- or Undershoot

It is also widely believe that instead of adjusting

smoothly, stock tend to overshoot the equilibrium price.

Chopra, Lakonishok, and Ritter (1992) report that

stocks that are extreme losers at time zero outperform those that were extreme winners over the following five years.
Bell, Kothari and Shanken (1995),report that abnormal

returns from the strategy become statically insignificant when changes in the betas of winners and losers are taken into account.

H. Cross-Sectional Puzzles

Day-of-the-Week Effect II. Year-End Effect


Day-of-the-Week Effect
French (1980) studied daily returns on the Standard and

Poors composite portfolio of the 500 largest firms on the NYSE over the period 1953 to 1977. The negative returns on Monday were highly significant. They were also significantly negative in each of the five-year subperiods that were studied. An immediate natural reaction to explain this phenomenon is that firms wait until after the close of the market on Fridays to announce bad news.

Year-End Effect
Stock returns decline in December of each year,

especially for small firms and for firms whose price had already declined during the year. The prices increases during the following January.
Roll (1983) reported that for 18 consecutive years

from 1963 to 1980, average returns of small firms have been larger than average returns of large firms on the first trading day of the calendar year.