Portfolio rebalancing and the turn-of-the-year e¤ect

This paper finds that, for the 1935-1986 period, the market’s risk-return relation does not have a January seasonal. The findings differ from those of other studies due to the use of value-weighted, rather than equally weighted, portfolios. Inferences are sensitive to the weighting procedure because of the small-firm return patterns in January. In particular, even in those Januaries for which the market return is negative, small-firm returns are positive, and they are more positive the higher is beta. This is consistent with the portfolio rebalancing explanation of the turn-of-the-year effect. SINCE AT LEAST 1926, THE average return on small firms in January has been unusually high, a phenomenon known as the turn-of-the-year effect. In this paper, we present new evidence regarding the risk-return characteristics of small firms in January. We find that, for small firms, there is a positively sloped risk-return relation in both up and down markets. This pattern is difficult to reconcile with the belief that the high return on small firms in January is equilibrium compensation for risk bearing