“New beginnings are in order, and you are bound to feel some level of excitement as new chances come your way.”
Auliq Ice
Abstract
We examine the cross-sectional January effect among portfolios that long sentiment-prone and difficult-to-arbitrage stocks and short sentiment-insensitive and easy-to-arbitrage stocks. These long-short portfolios on average earn over 20 times higher returns in January than in a non-January month. 85% of the cross-sectional January effect comes from its long legs, consistent with a sentiment-driven mispricing explanation. The cross-sectional January effect persists over time and remains significant after accounting for common risk factors and time-varying factor loadings.
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Notes
Our results are weaker but remain consistent when the portfolios are value-weighted.
We consider the change in the sentiment index because we are interested in the stock returns in January. In the model of De Long et al. (1990), the price of the risky asset is linear in the market sentiment, and therefore the return is linearly related to the change in investor sentiment.
We also examine whether the composite sentiment indicator of Baker and Wurgler (2006) has a January effect. This workhorse sentiment indicator is a market-based sentiment index that was extracted as a common component of five sentiment proxies, including closed-end fund discount, the number and the first-day returns of IPOs, the equity share in total new issues, and the dividend premium. We find that, among all months, the level (increment) of Baker-Wurgler sentiment is the highest (second highest) in January.
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Cheema, A.K., Ding, W. & Wang, Q. The cross-section of January effect. J Asset Manag 24, 513–530 (2023). https://doi.org/10.1057/s41260-023-00324-1
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DOI: https://doi.org/10.1057/s41260-023-00324-1