AN INVESTIGATION OF THE RETURN AND RISK PREMIUM SEASONALITIES AND THE FIRM SIZE EFFECT OF THE SINGAPORE STOCK MARKET

Abstract

In recent years, empirical studies of equity markets have uncovered a variety of anomalies. These anomalies are exceptions to well established paradigms of finance for which no satisfactory explanations are found. Amongst the many "puzzies" that still baffle financial economists, are the January effect and the firm size effect. The January effect refers to the persistently high returns that occurs in the first month of the calender year - January. Size effect is the phenomenon that the market capitalisation of a firm can explain returns· as well as risk does. Other things being equal, the smaller the market value of firm the larger is the stock's expected return. Even increasing the mystery surrounding these two anomalies is the discovery that, on average, most of the high January mean returns are due to small firms. Interestingly, for the simple structures constructed by asset pricing models eg. CAPM, it is discovered that January is the 011/y month to have a positive tradeoff of return for risk. In other words, CAPM is valid only in the month of January! Confounding financial researchers further, it is also detected that the January effect in CAPM risk premia is present 011/y for small firms. While these evidence accrue to the U.S stock markets, research effort directed at small exchanges like the Stock Exchange of Singapore (SES) is .scant. This Academic Exercise therefore serves to fill this void. Specifically, this research seeks to investigate the presence of seasonality in monthly returns and risk premia. The association between size and ·seasonality is also examined. Monthly returns of market indices (Stock Exchange of Singapore AU-share and Straits Times Industrial indices) are used to test for seasonal effects. Seasonality is also investigated using portfolio raw and excess returns. Results indicated a presence of January effect in both indices and portfolio returns. However, there is evidence that the magnitude of the effect decreases across subperiods. Adjusting for risk, there seems a dissipation of the high returns in January. Using the Fama-Macbeth methodology, monthly risk premia are investigated for the presence of seasonal behaviours. Results show that, unlike the U.S., no January effect exists in the CAPM risk premia for Singapore. Also, there is no association between returns and risk premia seasonality. The data is investigated for size effect by replicating major works done in this area. No consistent evidence of size effect is indicated in the results. Little association is present between seasonality (returns anJ risk premia) and size effect. These evidence point to the fact that the Janaury effect is quite a different phenomenon from that in the U.S .. The implications of the findings have a direct bearing on portfolio performance - an issue of timing. A strategy can be formulated to capitalise on the apparent regularity. However, the fact that the January effect has existed for many years does not mean that it will continue to persist into the future. This is especially so if the evidence suggests that the magnitude of the effect is decreasing. Moreover, if the January effect in Singapore is not caused by higher returns of small firms for which there are intelligent conjectures for their occurrence, then high returns in Singapore could just be due to the correlation of returns between U.S. and Singapore. Therefore if an economic basis exists for the January effect in U.S., then high returns in January should be reflected in the stock returns worldwide, including Singapore.