Seasonalities in Stock Returns

An interesting academic paper related to a lot of seasonality strategies, but mainly to:

#125 – 12 Month Cycle in Cross-Section of Stocks Returns

Authors: Hirschleifer, Jiang, Meng

Title: Mood Beta and Seasonalities in Stock Returns



Existing research has documented cross-sectional seasonality of stock returns – the periodic outperformance of certain stocks relative to others during the same calendar month, weekday, or pre-holiday periods. A model based on the differential sensitivity of stocks to investor mood explains these effects and implies a new set of seasonal patterns. We find that relative performance across stocks during positive mood periods (e.g., January, Friday, the best-return month realized in the year, the best-return day realized in a week, pre-holiday) tends to persist in future periods with congruent mood (e.g., January, Friday, pre-holiday), and to reverse in periods with non-congruent mood (e.g., October, Monday, post-holiday). Stocks with higher mood betas estimated during seasonal windows of strong moods (e.g., January/October, Monday/Friday, or pre-holidays) earn higher expected returns during future positive mood seasons but lower expected returns during future negative mood seasons.

Notable quotations from the academic research paper:

"We propose here a theory based on investor mood to offer an integrated explanation for known seasonalities at both the aggregate and cross-sectional levels, and to offer new empirical implications which we also test. In our model, investor positive (negative) mood swings cause periodic optimism (pessimism) in evaluating signals about assets’ systematic and idiosyncratic payoff components. This results in seasonal variation in mispricing and return predictability.

Consistent with the model predictions, we uncover a set of new cross-sectional return seasonalities based on the idea that stocks that have been highly sensitive to seasonal mood fluctuations in the past will also be sensitive in the future. In other words, we argue that some stocks have higher sensitivities to mood changes (higher mood betas) than others, which creates a linkage between mood-driven aggregate seasonalities and seasonalities in the cross-section of returns. In particular, we argue that investor mood varies systematically across calendar months, weekdays, and holidays. In consequence, a mood beta estimated using security returns in seasons with mood changes helps to predict future seasonal returns in other periods in which mood is expected to change.

During our sample period 1963-2015. the average stock excess return (measured by CRSP equal-weighted index return minus the riskfree rate) is highest in January and lowest in October. Thus, we focus on January as a proxy for an investor high-mood state and October for a low-mood state. Using Fama-MacBeth regressions, we verify the finding of Heston and Sadka (2008) for January and October—historical January (October) relative performance tends to persist in future January (October) for the following ten or more years. In our interpretation, stocks that do better than others during one month will tend to do better again in the same month in the future because there is a congruent mood at that time.

Furthermore, we find a new reversal effect that crosses months with incongruent moods; historical January (October) returns in the cross section tends to significantly reverse in subsequent Octobers (Januaries). A stock that did better than other stocks last January tends to do worse than other stocks in October for the next five years or so. A one-standard-deviation increase in the historical congruent (incongruent)-calendar-month leads an average 23% increase (17% decrease) in the next ten years, relative to the mean January/October returns.

Our explanation for these effects is not specific to the monthly frequency. A useful way to challenge our theory is therefore to test for comparable cross-sectional seasonalities at other frequencies. Moving to the domain of daily returns, we document a similar set of congruent/incongruent-mood-weekday return persistence and reversal effects.

We confirm this return persistence effect for Monday and Friday returns, and then show, analogous to the monthly results, that a congruent-mood-weekday return persistence effect applies: relative performance across stocks on the best-market-return (worst-market-return) day realized in a week tends to persist on subsequent ten Fridays (Mondays) and beyond, when good (bad) market performance is expected to continue. A one-standard-deviation increase in historical congruent-weekday or congruent-mood-weekday return is associated an average with a 4% or 12% higher return in the subsequent ten Mondays/Fridays.

At the level of individual stocks, there is pre-holiday cross-sectional seasonality, wherein stocks that historically have earned higher pre-holiday returns on average earn higher pre-holiday returns for the same holiday over the next ten years.

The cross-sectional return persistence and reversal effects across months, weekdays, and holidays are overall consistent with our theoretical predictions that investors’ seasonal mood fluctuations cause seasonal misperceptions about factor and firm-specific payoffs and lead to cross-sectional return seasonalities. These predictions are based on the idea that different stocks have different mood beta—a stock’s return sensitivity to factor mispricing induced by mood shocks. We argue that the concept of mood beta integrates various seasonality effects. We therefore perform more direct tests of the model prediction that mood betas will help forecast the relative performance of the stocks in seasons with different moods."

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