January effect in the london stock market

1. INTRODUCTION

Capital markets are the markets for securities, where companies and governments appeal to raise long-term funds. Capital markets include the stock market and the bond market, but for the purpose of the following dissertation only the stock market would be analyzed. The stock market is define as a private or public market for the trading of company stock and derivatives ofcompany stock at an agreed price, both (stock and derivates) are securities listed on a stock exchange as those only traded privately.

A Stock Exchange is the most important component of the stock market, is the share market, also define as the mutual organization which provides facilities for stock brokers and traders, for the purpose of trading company stock and other securities providingfacilities for the issue and redemption of securities as well as other financial instruments and capital matters, for example the payment of income and dividends. The securities trade in a Stock Market include: shares issue by companies, unit trusts and bonds. To be able to trade a security in a particular Stock Exchange, it has to be listed there, in this regard a central location with recordkeepingis usually use, but due to electronic networks that keep trade less linked to such a physical place, central locations are revalue as being centres for trade. Trade and exchange is performed only by its members. In a Stock Market supply and demand is influenced by various factors, which like in all free markets; drive the price of the stocks.

Financial Theory assumes that stock markets areefficient, (Efficient Market Hypothesis (EMH)), the hypothesis explains that securities markets are efficient because prices of securities reflect their economic value, in this order an efficient market can be defined as one in which all information is reflected in the stock prices quickly and fully. In a perfect efficient market, securities prices reflect all the available information and investorswould not be able to use any other kind of information to earn abnormal returns, because the information in concern would already be considered in the price of the security. In this market a security price is equal to its intrinsic value, reflecting all information about the security prospects.

When some type of information is not fully reflected in the price or when lags exists in theimpoundment of information into prices, the market is less than perfectly efficient, in this scenario the market is not perfectly efficient nor perfectly inefficient, certainly being a matter of degree.

In 1970, Fama proposed dividing the Efficient Market Hypothesis into three categories that generally have been used to define efficient markets, the tree classifications can be summarized asfollows: a weak form which considers that prices of securities reflect all price and volume data, a semi strong form stating that prices reflect all publicly available information and the strong form that consider that prices reflect all information public and private.

However there is evidence of existing market anomalies that do not correspond consistently with the Efficient Market Hypothesis(EMH). An anomaly is an exception to a rule or model, and thus these market anomalies are in contrast to what would be expected in a totally efficient market, constitute exceptions to market efficiency.

Several studies have found that the average rate of return for stocks in the month of January is higher than the average return for other months in a year, the anomaly is conventionally known asthe “January Effect”, sometimes called the “turn of the year effect", and it has been defined as a “calendar effect” or “seasonal pattern”, where stocks, especially small-cap stocks, experience higher returns in January and exceptionally larger during the first few trading days of January, compare to the returns of ordinary large cap stocks.

In this sense several researchers have documented...