ALL THINGS CONSIDERED, TAXES DRIVE THE JANUARY EFFECT….pdfVIP

The Journal of Financial Research • Vol. XXVII, No. 3 • Pages 351–372 • Fall 2004 ALL THINGS CONSIDERED, TAXES DRIVE THE JANUARY EFFECT Honghui Chen University of Central Florida Vijay Singal Virginia Tech Abstract The multitude of explanations for the January effect leaves the reader confused about its primary cause(s): is it tax-loss selling, window dressing, information, bid-ask bounce, or a combination of these causes? The confusion arises, in part, because evidence has generally been presented in support of a particular hy- pothesis though the same evidence may be consistent with another hypothesis. Furthermore, prior work does not adequately control for the bid-ask bounce. In this article we try to disentangle different explanations of the January effect and identify its primary cause. We find that tax-related selling is the most important cause, overshadowing other explanations. JEL Classifications : G10, G12, G14 I. Introduction There is considerable evidence of a January effect in U.S. equity markets; that is, some stocks experience large mean returns in January.1 Keim (1983) and Reinganum (1983) find that the January effect exists primarily for small firms. Roll (1983) argues that because the more volatile stocks are likely to be ex- treme losers (and winners) and because the final size of the losing stocks will be small, it is not surprising to find that the January effect exists primarily for small firms. Various explanations are advanced: window dressing, information, tax-loss selling, and bid-ask b