Month-end effect on Chinese stock returns: explanation of the liquidity hypothesis

ABSTRACT

This study focuses on an anomaly in the intramonth pattern of stock returns and defines it as the ‘month-end effect’. The mean return for stocks is negative for the month-end days. Moreover, this study provides an economically plausible explanation for the month-end effect, namely, the liquidity hypothesis. It is suggested that the increase in the liquidity demand of commercial banks at the month-end days generally induces a fall in stock returns at the end of each month. Finally, additional evidence is provided that the window dressing hypothesis and macroeconomic news announcements hypothesis have limited explanation for the month-end effect.

KEYWORDS:

• Month-end effect
• liquidity hypothesis
• window dressing
• news announcement

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The Equity Split Reform was implemented on 9 May 2005. By the end of 2006, a total of 1,301 listed companies had completed reforms in Shanghai and Shenzhen, accounting for 97% of the total listed companies.

2. On 1 January 2007, the ‘Notice of the China Banking Regulatory Commission on the Official Operation of the Off-site Supervision Information System in 2007’ was officially put into operation. According to the regulations of the China Banking Regulatory Commission, reporting frequency is divided into months, quarters, half-years, and years based on risk characteristics, regulatory requirements, and reporting costs.

3. Taking GC001 as an example, the transaction volume of GC001 in early 2006 was almost zero, but, at the beginning of 2007, the transaction volume was 836 million. Data come from the Wind database.

4. As Ritter (1988) points out, the portfolio composition of individual investors is more intensive in low-priced, low-capitalization stocks. Therefore, investors are more likely to sell stocks with small size in liquidity shortage.

5. A repo, also known as a sale and repurchase agreement, is a collateralized loan with an extremely short maturity (often overnight). The major net borrowers in the repo market include large banks and dealers of government securities. The net lenders tend to be mutual funds, pension funds, and corporations (see Owners and Wu, 2015). The borrowers receive cash from the lender and transfer to the lender securities as collateral (typically government securities, corporate bonds). It is agreed up front that the securities will be transferred back to the borrower when it repays the borrowed cash plus interest. The attractiveness of repo borrowing comes from the large repo market size, low borrowing rates, and maturities that can be tailored to needs. Increasing the repo rate on the repurchase market is the bank’s main method for raising funds to meet the immediate capital requirements.

6. We thank the anonymous referee for pointing out this issue.

7. The China Commodity Futures Index (CCFI) is a comprehensive commodity futures index developed by the China Futures Market Monitoring Center (CFMMC), which can be used as a benchmark for commodity futures market returns and investment tracking targets. The index was released on 10 January 2012.

Additional information

Funding

This article is funded by the National Natural Science Foundation of China (71790594, 71771170, U1811462), the Major Fund of Tianjin Municipal Education Commission (2018JWZD47) and the Applied Economics of Nanjing Audit University of the Priority Academic Program Development Phase III of Jiangsu Higher Education Institutions (Office of Jiangsu Provincial People’s Government, No. [2018]87).