McGraw-Hill

Forecasting the Size Effect 167
Seasonalities in risk, in the release of information, and in insider
trading activity have been proposed to explain the January
size effect. Rogalski and Tinic (1986) found that both the systematic
and nonsystematic risks of small stocks rise in January, but not by
enough to account for the observed return pattern. Arbel (1985)
cited year-end release of accounting information as a potential explanation
of a neglect-driven size seasonal .in January. But Chari,
Jagannathan, and Ofer (1986) found no excess return at fiscal year
end for companies that do not have a December year end, casting
doubt on the informational hypothesis. Seyhun (1988) found that
small-firm insiders adjust their positions around year end, but that
insider trading activity does not explain the January size seasonal.
Roll (1983b) and Reinganum (1983b) have examined year-end
tax-loss-selling as a possible explanation for the small-firm January
seasonal. This research was motivated by Branch (1977) and Dyl
(1977), who had earlier reported evidence of tax-loss-selling consistent
with the observed January effect. The tax hypothesis maintains
that investors establish losses to shelter taxable income prior to the
new year. Once the year-end selling pressure abates around the
turn of the year, prices rebound.
Roll regressed securities’ turn-of-the-year returns on their returns
over the preceding year and found a significant negative relationship.
Those securities experiencing negative returns in the
preceding year were more likely to be subject to tax-loss-selling and to
bounce back early in the new year. Roll conjectured that the effect
largest for small firms because they are more likely candidates tax- for
loss-selling, given their higher volatility and lower relative repres
tion in tax-exempt institutional portfolios. Also, the higher transaction
costs for smaller firms inhibit arbitrage of the January seasonal.
Reinganum constructed a measure of potential tax-loss-selling
by using the loss suffered from the high price in the previous period,
classified for tax purposes as short term. While he found the
size seasonal early in January consistent with tax-loss-selling, the
entire January size effect could not be fully explained. Inconsistent
with the tax-loss hypothesis was the finding that last year’s win
outperformed in January.
Several studies provide an international perspective on the
January-size connection. Brown et al. (1983) examined stock returns
in Australia, where the tax year June ends 30. They found that mar-