Financial Markets and Asset Pricing

Abstract

Anomalies are empirical results that seem to be inconsistent with maintained theories of asset-pricing behavior. They indicate either market inefficiency (profit opportunities) or inadequacies in the underlying asset-pricing model. After they are documented and analyzed in the academic literature, anomalies often seem to disappear, reverse, or attenuate. This raises the question of whether profit opportunities existed in the past, but have since been arbitraged away, or whether the anomalies were simply statistical aberrations that attracted the attention of academics and practitioners. One of the interesting findings from the empirical work in this chapter is that many of the well-known anomalies in the finance literature do not hold up in different sample periods. In particular, the size effect and the value effect seem to have disappeared after the papers that highlighted them were published. At about the same time, practitioners began investment vehicles that implemented the strategies implied by the academic papers. The weekend effect and the dividend yield effect also seem to have lost their predictive power after the papers that made them famous were published. In these cases, however, I am not aware of any practitioners who have tried to use these anomalies as a major basis of their investment strategy. The small-firm turn-of-the-year effect became weaker in the years after it was first documented in the academic literature, although there is some evidence that it still exists. Interestingly, however, it does not seem to exist in the portfolio returns of practitioners who focus on small-capitalization firms. Likewise, the evidence that stock market returns are predictable using variables such as dividend yields or inflation is much weaker in the periods after the papers that documented these findings were published. All of these findings raise the possibility that anomalies are more apparent than real. The notoriety associated with the findings of unusual evidence tempts authors to further investigate puzzling anomalies and later to try to explain them. But even if the anomalies existed in the sample period in which they were first identified, the activities of practitioners who implement strategies to take advantage of anomalous behavior can cause the anomalies to disappear (as research findings cause the market to become more efficient).