The January Effect and Prospect Theory in Taiwan

Abstract

ABSTRACTProspect theory can predict the January effect. The capital gains overhang is a dominant variable in predicting the January effect, and past returns are only a noisy proxy. Empirical results based on date from Taiwan support our argument. At the beginning of every January, as proposed by the prospect theory, stocks with the lowest capital gains overhang induce investors to hold on to their losing stocks, which in turn restricts available supply and reduces selling pressure in January. Thus, because investors are willing to sell only at a premium, trading takes place at an inflated price, which causes the January effect.