A Survey on the Weekend Effect

Unusual stock market return activities has been a major topic of empirical finance research for a few decades now. Seeing the objectives of an investor are to always make profitable investments, they will jump for opportunities where abnormal profits can be made due to market inefficiency. Over the past 40 years, researchers have identified a number of inconsistent empirical results with maintained asset-pricing theories; these are called financial market anomalies. The term “anomaly” itself can be traced back to Kuhn (1970) in his book “The structure of scientific reductions”. Financial anomalies that are associated with time are called calendar effects. Examples of these include the turn-of-the-month effect, the January effect and the weekend effect. Description of the weekend effect

The financial anomaly which will be closely observed in this research is the weekend effect. “The weekend effect is a phenomenon in financial markets where stock returns on Mondays are often significantly lower than those of the immediately preceding Friday.”[1] Since most financial markets close on the Friday evenings for the weekend, this means Monday returns span over three days. Therefore, it could be expected that returns on a Monday should be higher than returns for other days of the week due to the longer period. In actual fact, Monday is the only weekday with a negative average rate of return. The weekend effect was first pointed out in 1973 by Frank Cross in the US markets. It was then documented in 1980 in the Journal of Financial Economics by Kenneth French, one of the first to prove the existence of this anomaly by studying the daily returns to the Standard & Poor’s (S&P) composite portfolio from 1953 to 1977. Donald Keim and Robert Stambaugh carried on further investigation in 1984.

Michael Gibbons and Patrick Hess added more evidence of negative Monday returns for the 30 individual stocks of the Dow Jones Industrial Index in 1981. French showed that the return for Monday was negative and lower than the average return for any other day. He also showed that the results contradict the calendar and trading time models which state that returns are only generated during trading periods and mean returns are the same for all trading days of the week. The histogram below illustrates the difference between the return for Monday compared to those of the other days of the week. C:\Users\Ben\Desktop\University\Year 2\Managing Money Finance\Coursework\french.jpg[2] From these histograms, it can clearly be seen that the mass of the returns for Monday is mostly in the negative region whereas the mass for the other days is more centred towards the positive region with Wednesdays and Fridays standing out, having higher returns than other days.

How does the weekend effect influence the market efficiency? Anomalies often show evidence of market inefficiency as they contradict the efficient market hypothesis (EMH), founded by Eugnene Fama (1960), which states that “stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.”[3] EMH indicates investors should not be able to make profit opportunities by buying under-priced stocks or selling them at inflated prices. The reason for this is because stocks should always be traded at their fair price. EMH states that it is not possible to outperform the market (except through luck). However it is technically possible for investors to earn abnormal profits, by buying undervalued shares on Mondays and selling them overvalued on Fridays. By doing so investors are beating the market and therefore this disputes EMH, suggesting that the market is inefficient. Furthermore, as mentioned previously, one of the main explanations to why the weekend effect occurs is the result of bad news being exposed after trading hours close on the Friday.

Consequently, this means that investors in the weekend effect are not rational. If they were, they would be able to expect the bad news which would be given over the weekend and incorporate it into the price before that weekend, which would eradicate the weekend effect. Therefore, it would be safe to say that the information is not perfect, seeing as there is a time delay between the awareness of the bad news and its announcement, so it can be said that the main assumptions of EMH are disputed for the weekend effect. The capital asset pricing model (CAPM) is “a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.”[4]

Firstly introduced by Sharpe in 1964, then carried on a year later by Lintner, it has since then been the dominant paradigm in financial economics. The purpose of this model is to give an idea of the risk and the expected return on an investment. As mentioned previously, in a financial market where market anomalies are present, such as the weekend effect, the EMH theory is contradicted which means the joint hypothesis of CAPM is being tested. However, CAPM remains a way of explaining the anomaly as it gives a calculation of how risky an investment will be. Nevertheless, since both the EMH and the CAPM do not predict the random behaviour of stock prices, investors do not use them to speculate future trends. What are the possible reasons behind the weekend effect?

There is no universally clarified explanation to why this anomaly occurs, although several have been suggested. French (1980) claimed the most obvious reason behind this market anomaly is unfavourable information that is released after the closure of the stock markets on Fridays. Since firms fear the consequences of bad news being announced such as “panic selling”, they delay the information announcements until the weekend in order to allow time for the information to sink in. Some may call this the negative flow hypothesis, however Schatzberg and Datta (1992) and Pettengill and Buster (1994) criticised this theory as they found firms are more keen to announce positive news rather than negative. Behaviour finance takes a look at the psychological and social factors that can affect investment decisions, making markets move away from efficient market theories; some tendencies may include limited attention, overconfidence and self-attribution biases. It may be suggested that buying behaviour contributed to existence of the weekend effect.

For instance, Miller (1988) found that individual investors make most investment decisions during the weekend, since they are busy with their other work duties throughout the week. Miller also suggests that these same individuals are more likely to sell on their own shares after having reviewed their portfolios during the weekend. Although his hypothesis seems realistic, Miller has shown no evidence to demonstrate why individual investors act the way he states they do. Sias and Stark (1995) argued in their hypothesis, the “individual investor hypothesis”, that institutional investors were those that were primarily responsible for the patterns in returns and volumes of the weekend effect. Firstly Sias and Stark suggested that investors avoid Monday trading and instead use that day for strategic planning, thus narrowing market depth. They call this “thinner Mondays” and specify the proof lies within the empirical evidence of small volume in block trades on Mondays. Furthermore, they also put forward that weekend effect patterns in returns and volume may also be caused by the interaction of informed traders, liquidity traders and market traders.

According to their research, informed traders require more information on Mondays than the other days of the week. “Another component of this hypothesis is that individual investors are faced with an asymmetry of brokerage recommendations for both form and time and whereas investors are not subject to these.”[5] The way they explain this is that brokers inspire individuals to buy, but only during trading periods, therefore, during the weekend, these individuals have the time to think without the purchasing recommendations from brokers. Finally in their hypothesis, they also stipulate that the weekend effect is related to autocorrelation in portfolio returns. Why does the weekend effect matter to both academics and practitioners? There is a vast amount of documented market anomalies that is currently known. This amount is constantly increasing due to academics that analyse through decades’ worth of data in order to discover a new anomaly. Anyone could wonder why academics would dissect through so information just to find results that seem to be inconsistent. The truth of the matter is reputation and job prospects.

From publicising their research thus revealing an anomaly, academics would increase their reputation since anyone interested or who works in the stock market will hear about them. Profit can be gained from the sales of the journals where the research is shown, for example, in the Journal of Financial Economics where French (1980) showed his work. However, academics such as finance professors may search slightly more than earnings made from publicising their work. Usually what they seek is new job prospects in the hopes that some institution will be interested in their skills. “Their research might land them a job at a hedge fund or at some other organisation and it can be said that trading a university salary for a share of a fund’s performance fee is a really attractive example of profitable arbitrage.”[6] Academics may also attempt to create an efficient market theory that works even with the existence of market anomalies by unveiling current ones. This market anomaly matters to practitioners as they may use it in an attempt to gain profit from its existence.

This usually occurs when some individual notices a non-random pattern in returns and decides to exploit it, in this case investing on the Monday and selling on the Friday. However, when the market is efficient, investors must accept they simply cannot beat the index of stock prices. Nevertheless, it is wrong to say that it is impossible for investors to outperform the market by buying and selling securities in an efficient market and if this occurs it would be luck and not skill. As it has been mentioned previously, seeing as the weekend effect contradicts the EMH, technically investors may attempt to beat the market. However the investors would have to think about transaction costs while attempting to exploit the anomalies of the market, as French argued. What has now happened to the weekend effect?

Based on past patterns and according to efficient market hypothesis, the consequence of anomalies being analysed and shown to the general public causes them to dissolve, as research findings cause the market to become more efficient. “This is exactly what happened with the weekend effect, once the papers made it famous, it lost its predictive power. The weekend effect seemed to have disappeared, or at least substantially attenuated, since it was first documented in 1980”[7] in the US. However, this market anomaly has not seemed to have completely disappeared as research in the Indian market examined by Roger Ignatius (1992) and Goloka Nath/Manjoy Dalvi (2004) for periods from 1979 up to 2003 indicates.

The conclusion of these two studies revealed the existence of a weak form of the weekend effect with once again no real explanation apart from unfavorable news emerging in weekends, pushing investors to sell on following Mondays. Outside of the US, it was found that the weekend effect was also occurring on an international scale such as in the Tokyo Stock Exchange (Jaffe & Westerfield, 1985), the London Stock Exchange (Theobald & Price, 1984), the Milan Stock Exchange (Barone, 1990) and many others. By those dates the weekend effect had already disappeared from the US markets, however, in 2000, Brusa, Lui and Schulman reported through their studies a “reverse” weekend effect. This anomaly is different to the “traditional” weekend effect since the Monday returns are positive as well as higher compared to any other day of the week. They suggested this reverse weekend effect was current from 1997 to 2000. Since the knowledge of this reverse weekend effect was revealed to the general public, in 2001, Monday returns went back to being smaller than any other day. “A negative, but statistically insignificant weekend effect in large stock reappears during this period. It may represent a reversal for the reverse weekend effect.” [8]So it can be said that since 2000 was recognised, the reversal weekend effect has disappeared.

It can therefore be said that the weekend effect has gone through its whole cycle: identification, exploitation, decline, reversal and disappearance. However, Olson, Chou and Mossman suggest that it is possible the weekend effect to reappear briefly, that is if investors become complacent and stop seeking for arbitrage opportunities involving seasonal effects. All in all, it can be said that investors are always on the lookout for new profit opportunities and market anomalies such as the weekend effect are a great way of achieving this. Since it has been shown that the weekend effect contradicts the EMH, this means this anomaly disputes market efficiency, making it possible for practitioners to gain abnormal profits. Academics, on the other hand, attempt to discover and publish them for their own interest. There are many assumptions that attempt to explain why this market anomaly occurs, none of which can be decided to be the only explanation. Even though the weekend anomaly is not currently documented, it has been documented in countries around the world within the last decade, showing just how international this market anomaly is. The weekend effect is the type of anomaly that has reversed before but this anomaly could also reappear at anytime if investors become complacent.

Bibliography:

Journals and books:

Brealey, R.A./Myers, S.C./Marcus, A.J. (2011). Fundamentals of Corporate Finance, 7/e)

Brooks, R.M. and Kim, H. (1997). The individual investor and the weekend effect: A re-examination with intraday data. Quarterly Review of Economics and Finance, 37, 725-737 Brusa, J, Lui, P and Schulma, C. (2000). The weekend effect “reverse” weekend effect, and firm size. Journal of Business Finance and & Accounting, 27, 555-574

Brusa, J, Lui, P and Schulma, C. (2005). The weekend effect “reverse” weekend effect, and investor trading activities, Journal of Business Finance and & Accounting, 32, 1495-1517 Chan, H and Singal, V. (2003). Role of speculative short sales in price formation: Case of the weekend effect, Journal of Finance, 58, 685-706

Connolly, R. A. (1989). An examination of the robustness of the weekend effect. Journal of Financial and Quantitative Analysis, 24, 133-169

Cross, F. (1973) The behaviour of stock price on Fridays and Mondays, Financial Analysts Journal, 29, 67-69

Dyl, Holland (1990), “Why a weekend effect?”, The journal of Portfolio Management

French, K.R. (1980). Stock returns and the weekend effect. Journal of Financial Economics, 8, 55-69 Gibbons, M. R & Hess, P. (1981). “Day of the week effects and asset returns” Journal of Business, pp579-596

Keim D, Stambaugh R. (1984) “A further investigation of the weekend effect in stock returns”, Journal of Finance Vol. 39 Issue 3, p819-835, 17p

Rogalski, R.J (1984). “New findings regarding day of the week returns over trading and non-trading periods: a note.” Journal of Financial Economics pp.1603-1614

Schwert G. W (2003) Anomalies and Market Efficiency, University of Rochester

Starks, M.S.L (1986). “Day of the week and intraday effects in stock returns”

Websites:
Investment Terms, 2012, Weekend effect. (online) available at http://investment_terms.enacademic.com/14865/Weekend_Effect last accessed 10/11/12 Financial Dictionary, 2012, EMH definition. (online) available at http://financial-dictionary.com/Efficient+Market+Hypothesis last accessed 10/11/12 Financial Dictionary, 2012, CAPM definition. (online) available at http://financial-dictionary.com/Capital+Asset+Pricing+Model last accessed 10/11/12 Sias, Starks, 1995, The role of institutional investors (online) available at http://www2.mccombs.utexas.edu/faculty/laura.starks/sias%20starks%20faj95.pdf last accessed 09/11/12 The Economist, 2012, keep digging (online) available at http://www.economist.com/news/finance-and-economics/21566016-treasure-buried-academic-papers-about-market-anomalies-keep-digging. Last accessed 09/11/12 Finance NSYSU, 2003, The Dynamics of the Weekend Effect, Chou. Olson, Mossman. Available at http://www.finance.nsysu.edu.tw/SFM/17thSFM/program/FullPaper/059-1650660442.pdf Last accessed 09/11/12

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[ 1 ]. Investment Terms, 2012, Weekend effect. (online) available at http://investment_terms.enacademic.com/14865/Weekend_Effect last accessed 10/11/12 [ 2 ]. French, K.R. (1980). Stock returns and the weekend effect. Journal of Financial Economics, 8, 55-69 [ 3 ]. Financial Dictionary, 2012, EMH definition. (online) available at http://financial-dictionary.com/Efficient+Market+Hypothesis last accessed 10/11/12 [ 4 ]. Financial Dictionary, 2012, CAPM definition. (online) available at http://financial-dictionary.com/Capital+Asset+Pricing+Model last accessed 10/11/12 [ 5 ]. Sias, Starks, 1995, The role of institutional investors (online) available at http://www2.mccombs.utexas.edu/faculty/laura.starks/sias%20starks%20faj95.pdf