more than in the United States.^4 As you shall see later in the chapter, Jan-
uary is the best month for both large and small stocks in many other
countries of the world.^5
How could such a phenomenon go unnoticed for so long by in-
vestors, portfolio managers, and financial economists? Because in the
United States, the returns in January are nothing special for large stocks
that form the bulk of those indexes that are analyzed. That’s not to say
that January is not a good month for large stocks, as large stocks do quite
well in January, particularly in foreign markets. But in the United States,
January is by no means the best month for stocks of large firms.Causes of the January Effect
Why do investors favor small stocks in January? No one knows for sure,
but there are several hypotheses. In contrast to institutions, individual
investors hold a disproportionate amount of small stocks, and they are
more sensitive to the tax consequences of their trading. Small stocks, es-
pecially those that have declined in the preceding 11 months, are subject
to tax-motivated selling in December. This selling depresses the price of
individual issues. In January after the selling ends, these stocks bounce
back in price.
There is some evidence to support this explanation. Stocks that have
fallen throughout the year fall even more in December and then often rise
dramatically in January. Furthermore, there is some evidence that before
the introduction of the U.S. income tax in 1913, there was no January
Effect. And in Australia, where the tax year runs from July 1 through June
30, there are abnormally large returns to small stocks in July.
If taxes are a factor, however, they cannot be the only one, for the
January Effect holds in countries that do not have a capital gains tax.
Japan did not tax capital gains for individual investors until 1989, but
the January Effect existed before then. Furthermore, capital gains were
not taxed in Canada before 1972, and yet there was a January Effect in
that country as well. Finally, stocks that have risen throughout the pre-CHAPTER 18 Calendar Anomalies 309
(^4) See Gabriel Hawawini and Donald Keim, “On the Predictability of Common Stock Returns:
World-Wide Evidence,” in Robert A. Yarrow, Vojislav Macsimovic, and William T. Ziemba, eds.,
Handbooks in Operations Research and Management Science, vol. 9, North Holland, 1995, Chap. 17, pp.
497–544.
(^5) For an excellent summary of all this evidence, see Gabriel Hawawini and Donald Keim, “The
Cross Section of Common Stock Returns: A Review of the Evidence and Some New Findings,” in Se-
curity Market Imperfections in Worldwide Equity Markets, Donald B. Keim and William T. Ziemba, eds.,
Cambridge, England: Cambridge University Press, 2000.