Seasonality in the Malaysian Stock Market: 1992-2002

Introduction Capital markets are generally considered efficient. The efficient market hypothesis (EMH) states that it is not possible to predict stock price and return movements using past price information. Researchers have recently collected evidence contrary to the EMH. One of the significant anomalies is the presence of the seasonal effect in stock returns. The existence of the seasonal effect negates the weak form of the EMH and implies market inefficiency. In an inefficient market, investors would be able to earn abnormal returns, that is, returns that are not commensurate with risk. There are a few empirical studies which have examined the issue of seasonality of stock returns in the emerging capital markets (ECMs). The objective of this study is to investigate the existence of seasonality in stock returns in Malaysia. We use monthly closing price data of the Kuala Lumpur Stock Exchange's Index, called EMAS, from January 1992 to June 2002 for this purpose. The Malaysian tax system differs from the USA and many other developed and developing countries. The resident and non-resident shareholders in Malaysia are not required to pay any taxes on the capital gains. Hence, the `tax-loss-selling' hypothesis should not provide an explanation for the seasonality in stock returns in Malaysia. Still if seasonality is found in the Malaysian stock market, then it should be due to the information hypothesis (Keim1). This study specified an autoregressive moving average model with dummy variables for months to test the existence of seasonality in stock returns. The results of the study confirmed the monthly effect in stock returns in Malaysia. But it did not support the `tax-loss selling' hypothesis. These findings have important implications for financial managers, financial analysts and investors. The understanding of seasonality should help them to develop appropriate investment strategies. Prelude There would exit seasonality in stock returns if the average returns were not same in all periods. The monthof-the-year effect would be present when returns in some months are higher than other months. In the USA and some other countries, the year-end month (December) is the tax month. Based on this fact, a number of empirical studies have found the `year-end' effect and the `January effect' in stock returns consistent with the `tax-loss selling' hypothesis. It is argued that investors, towards the end of the year, sell shares whose values have declined to book losses in order to reduce their taxes. This lowers stock returns by putting a downward pressure on the stock prices. As soon as the tax year ends, investors start buying shares and stock prices bounce back. This causes higher returns in the beginning of the year, that is, in the month of January. In the US market, a number of studies have found the seasonal or the year-end effect in stock (Wachtel2; Rozeff and Kinney3; Keim1; Reinganum4). There is also evidence of the day-of-the-week effect in the US (Smirlock and Starks5) and other markets (Jaffe and Westerfield6) and intra-month effects in the US stock returns (Ariel7). The existence of seasonal effect has also been found in Australia (Officer8; Brown, Keim, Kleidon and Marsh9), the UK (Lewis10), Canada (Berges, McConnell, and Schlarbaum11; Tinic, Barone-Adesi and West12) and Japan (Aggarwal, Rao and Hiraki13), Boudreaux14 , Kato and Schallheim15 reported the presence of the month-end effect in markets in Denmark, Germany and Norway. In a study of 17 industrial countries with different tax laws, Gultekin and Gultekin16 confirmed the January effect. Jaffe and Westerfield17 found a weak monthly effect in stock returns of many countries. The research on the seasonal effect in the ECMs has started surfacing recently. A few studies have revealed the presence of seasonal effect of stock returns for the ECMs (Aggarwal and Rivoli18; Ho19; Lee Pettit and Swankoski20; Lee21; Ho and Cheung:22; Kamath, Chakornpipat, and Chatrath23; and Islam, Duangploy and Sitchawat24). …