The January Effect and the New December Effect

Abstract

Abstract Small loser stocks are known to appreciate considerably in January, giving rise to the so-called January effect. The primary explanation for the January effect is tax-loss selling by investors in December to realize capital losses that are used to offset capital gains. When the selling pressure abates in January, the loser stocks appreciate. Unfortunately, it is not possible to arbitrage the January effect, though investors can gain by changing their trading patterns. The December effect is similar in spirit to the January effect. Stocks that have done well in the January-November period are not sold by investors in December because selling those stocks will result in taxable capital gains. By waiting a few days, investors can postpone payment of capital gains taxes by almost one year. It is relatively easy to gain from the December effect, as popularly available indexes can be used for trading. Academics, practitioners, and investors have known about the January effect for decades. It is generally accepted that the January effect is a consequence of tax-loss selling. Since investors must pay taxes on net capital gains, investors sell losers toward year-end to realize capital losses that can offset capital gains. Thus, past losers experience abnormal selling pressure in December. In January the selling pressure is relieved, resulting in large gains for loser stocks. Evidence of large January returns for loser stocks is dubbed the January effect.