Cost of Capital: Applications and Examples, + Website, 5th Edition

APPENDIX 15A

Other Data Issues Regarding the Size Effect¹

Seasonality

Bid/Ask Bounce Bias

Delisting Bias

Transaction Costs

SEASONALITY

The “January effect” is the empirical observation that rates of return for small stocks have on the average tended to be higher in January than in the other months of the year. The existence of a January effect, however, does not present a challenge to the small-stock effect. This is true unless it can be established that the effect is the result of a bias in the measurement of returns. Some academics have speculated that the January effect may be due to a bias related to tax-loss selling.

Investors who have experienced a loss on a security may be motivated to sell their shares shortly before the end of December. An investor makes such a sale in order to realize the loss for income tax purposes. This tendency creates a preponderance of sell orders for such shares at year-end. If this is true, then (1) there may be some temporary downward pressure on prices of these stocks, and (2) the year-end closing prices are likely to be at the bid rather than at the ask price. The prices of these stocks will then appear to recover in January when trading returns to a more balanced mix of buy and sell orders (i.e., more trading at the ask price).

Such “loser” stocks will have temporarily depressed stock prices. This creates the tendency for such companies to be pushed down in the rankings when size is measured by market value. At the same time, “winner” stocks ...