STOCK MARKET ANOMALIES

UC3M BANKING CLUB

JUAN PABLO CONEJERO Y HERRERA
INDEX
• Introduction: Why are there anomalies?
• What happen in the short and long run?
• Different types of anomalies.
• How we can take advantage of them.
WHAT IS AN ANOMALY?

• An anomaly is any fluctuation, positive or negative, that

cannot be explained by traditional finance theory.
• Let’s see an example:
5:12 OPEC announces
new agreement
Price reacts quickly
How is it possible?
WHAT IS AN ANOMALY?

• OPEC’s announcement  Justifies that price goes up.

• There are small fluctuations needed to equilibrate demand
and supply.
• However why do big fluctuations take place?
• We could argue that these anomalies just happen in the short
run when the market has not yet adjusted, therefore in the
long run we shouldn’t find anomalies... do we?
THREE FORMS OF EFFICIENCY:

• The market can be efficient in three different ways:

• Weak form: Only historical price data is reflected in today’s
stock price.
• Semi-strong form: All publicly available information is
reflected in today’s stock price
• Strong form: All publicly available information + insider
knowledge is reflected in today’s stock price
THREE FORMS OF EFFICIENCY

• The Efficient Market hypothesis states that our financial markets are
semi-strong efficient this means that the stock price does not
contain all the information in the short run but it does in the long
run.
• Hence, in the short run there could be anomalies in the stock price
but not in the long run when all the information is disclosed.
• We will see in the following slides that there are anomalies in both
short and long run.
ANOMALIES

• There are four types of anomalies:

• Calendar  Weekend effect
• Fundamentals  P/E ratio effect
• Structure  IPO lockups
• Behaviour  Home bias
WEEKEND EFFECT

• In 1980 Kenneth R. French found that there is a tendency for

returns to be negative on Mondays whether they are positive
on the other days of the week.
WEEKEND EFFECT
P/E RATIO EFFECT

• Portfolio with a lower average P/E ratio has a higher average risk-
adjusted returns than those with high P/E stocks.
• It seems investors interpret a low P/E as an under-pricing. A buying
stream bolsters their price (and thus their P/E) and contribute to
give them, in average, better risk-adjusted returns than other
stocks.
EXPIRY OF IPO LOCKUPS

• IPO lockups: Agreement made by insiders of the stock-issuing firms

to abstain from selling shares for a specified period of time after
the issue.
• This creates an incentive to under-priced the IPO:
• Early studies by Reilly and Hatfield (1969) and Stoll and Curley (1970) show a
significant difference between the offering price of IPOs (determined by the
firm and the underwriter) and the first-day or first-week closing market price.
• From 1990to 2001, first-day returns on U.S. IPOs were approximately 25 %.
HOME BIAS

• According to MPT, an optimal portfolio should consist of a large

number of assets which should include both domestic and foreign
stocks. However, empirical research tends to show that investors
hold a substantially larger proportion of their wealth portfolios in
domestic assets, a phenomenon called equity home bias.
HOME BIAS
HOME BIAS
HOW CAN WE TAKE ADVANTAGE OF THESE ANOMALIES?

• Weekend effect  Buying regularly on Monday and selling on

Friday may bring abnormal returns.
• P/E ratio  Buying stocks with lower P/E ratio will provide us with
higher risk-adjusted returns.
• Expiry of IPO Lockups  IPOs prices are generally (but not always)
under-priced, hence investing in IPOs could be a good option.
• Home bias  Remember to diversify geographically portfolio to
obtain higher returns.
FURTHER INFORMATION

• Applied Asset and Risk Management: Marcus Schulmerich,Yves-

Michel Leporcher, Ching-Hwa Eu