Seasonality in Canadian Stock Prices: A Test of the "Tax-Loss-Selling" Hypothesis

Abstract

A popular hypothesis to explain the anomalous returns of common stocks is based on the argument that there is considerable tax-loss selling by investors toward the end of the year. The purpose of this study is to test the tax-loss-selling hypothesis with data on Canadian stocks. Although the introduction of capital gains tax in Canada seems to have affected the behavior of stock returns, the findings do not support the proposition that taxinduced trading is the sole cause ofthe seasonality in stock returns in Canada. I. Introduction Over the past several years, a number of studies have shown that the returns on common stocks, in general, and the stocks of small companies, in particular, tend to be abnormally high during the month of January. Keim [10] demonstrated quite clearly that a very high percentage of the abnormal positive returns gener? ated on stocks with low market capitalizations occurs during January, with the returns during the first five trading days of the year accounting for most of the anomalous behavior. His results were recently confirmed by Roll [14], who re? ported that around 37 percent of the annual differences in the returns on the equally-weighted and value-weighted indices of NYSE and AMEX stocks is ac? counted for by what happens in the five trading days from the last trading day in December through the fourth trading day in January. A popular hypothesis to explain the so-called January effect in stock re? turns is based on the argument that there is considerable end of the year tax-lossselling by investors. Originally proposed by Wachtel [19], it asserts that inves? tors try to realize losses towards the end of the year to reduce their taxes, thereby putting downward pressure on stock prices. According to the hypothesis, once