P/e Effect, Size Effect and Year-End Effect

When the market is moderately efficient, it is clear that this school of analysis is completely meaningless to its users because stock prices have reflected all the information published from the financial reports of the companies themselves and the use of this information cannot bring any outstanding benefits to investors. However, when the market is inefficient or weakly efficient, it is clear that the fundamental analysis school really dominates, which is a challenge to EMH. But certainly the theory of fundamental analysis cannot completely deny the role of EMH because wise investors in the market, when using fundamental analysis tools, gradually make the market more efficient because at this time the price is a good signal to reflect the intrinsic value of the stock.

1.3.3. Behavioral finance theory

Behavioral finance theory, with its fundamental premise that “the market is not always right,” has provided a major counterweight to the EMH. The efficient market theory is based on the belief that there is always a mechanism to correct the market to an efficient state, which is the arbitrage mechanism. Once there is a mispricing phenomenon in the market, meaning that the prices of financial market instruments do not accurately reflect their fair value (based on fundamental factors), there will be arbitrage opportunities, and “rational investors” who take advantage of these opportunities (buying undervalued assets, selling overvalued assets) will contribute to correcting the market to a reasonable or equilibrium state.

Behavioral finance theory suggests that such a correction mechanism may not always occur, meaning that there will be cases where “rational” investors cannot beat “irrational” investors and when

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In that case, the market would be inefficient, or “wrong” (i.e., over- or under-pricing stocks or other financial products).

Behavioral finance theory is a development that combines psychology into finance and this school of thought also began to be studied very early (since the 1880s), and later it also had significant developments. According to [14] and [27], from the fundamental works of Amos Tversky and Daniel Kahneman (1979), Richard H. Thaler (1985) and especially Robert Shiller with the famous book "Irrational Exuberance" (2000), accurately predicted the collapse of the global stock market not long after, creating a major turning point for behavioral finance researchers to continuously publish new studies. In addition, an important study in 1993 by Jegadeesh and Titman that is still a challenge for the Efficient Market school is the momentum effect, with more and more versions proposing how to exploit this effect to earn superior returns with low risk (the latest version is the study by Sagi and Seasholes published in 2007) with results that cannot be explained by efficient market models.

The models proposed by behavioral finance theory will likely be correct if one of the following three basic conditions exists in the market:

- Existence of unreasonable behavior.

- Systemic irrational behavior.

- Limit the ability to trade price differences in financial markets.

If all three exist, behavioral finance theory predicts that mispricing not only exists, but is significant (large or severe) and persistent.

Thus, in a market where many phenomena in the above factors appear, that market is heavily influenced by behavioral finance theory and the market is unlikely to follow EMH.

1.3.4. Adaptive Market Theory (AMH)

The efficient market theory with the familiar identity of EMH has now been considered more carefully by some researchers and with it comes the name AMH (Adaptive Market Hypothesis), that is, the highly adaptive efficient market. It is explained as taking into account the irrational actions of market participants and paying more attention to the behavior of each group of subjects in the market (like in biology: taking into account each species, each class ...).

AMH is accepted in the short run, explaining many events that EMH cannot explain. AMH seems to accept the paradox that EMH often presents. The paradox is that if all investors participating in the market believe that the market is efficient, then the market is inefficient because there is no incentive for investors to analyze securities to select securities that are undervalued to change their investment portfolios, thus, the market declines due to low liquidity. In fact, the efficiency of the market depends on the market participants' belief that the market is inefficient and that analysis to select securities is necessary in an effort to find higher returns than the market average. Thus, the market becomes always active with high liquidity.

Above are some theories in finance intertwined with the efficient market theory, always a counterweight to the efficient market theory. However, these theories only prevail in the short term, when the market is temporarily inefficient. And it should also be noted that, when the market is efficient at a certain level, such as weak or medium efficiency, or even inefficient, schools such as fundamental analysis, technical analysis, etc. have been mentioned.

The above still coexists with EMH, and the financial market still needs EMH as a measure to determine its efficiency.

1.3.5. Some cases (effects) appear besides the efficient market theory

The efficient market theory is often argued that the market is always right. However, while observing and practicing in the stock market, this theory is not always easy to accept, there have been many views pursuing the idea: "the market is not always right" and it has actually become a challenge to the efficient market theory. We also need to consider these cases.

1.3.5.1. P/E effect, size effect and year-end effect

P/E is an important indicator in evaluating stocks. It is also known as the stock multiplier. Knowing the after-tax profit of a company will immediately calculate the value of the company and the corresponding value of the stock when multiplying the after-tax profit by P/E. Different companies have different P/E, leading to studies on the effect of P/E on stock prices. There are studies showing that stocks with high P/E have lower abnormal returns than stocks with low P/E (Basu).

Many studies have shown that P/E is actually just a superficial effect of size. The assessment of P/E effect has been almost replaced by the assessment of size effect, but not vice versa. Tests of size effect show that stocks of small-sized enterprises (weighted by capitalization) achieve higher abnormal returns than those of large-sized enterprises even at relatively high P/E. However, corresponding to higher abnormal returns, the risk for small enterprises is greater. Therefore, the strategy of investing in stocks of small-sized enterprises

There is no dominance in practice because stock investors, while interested in the benefits, also pay attention to the risks involved.

A typical example of this is the study of the size effect by Ibbotson in 1984. Ibbotson created a portfolio of 50 stocks of the smallest companies, proportionate to their market capitalization, and held the portfolio for five consecutive years. This was repeated over the period 1926-1983 to ensure that the portfolio contained only stocks of the smallest companies. The results were compared with a portfolio of SP500 stocks over the same period.

Regarding the size effect, according to [10], Keim (1983) also found that the size effect is strongest in January of each year, as shown by the difference in stock interest rates between the two groups of small and large enterprises being the highest in this month. More specifically, Roll (1983) also pointed out that the size effect is strongest on the last day of December of the previous year and lasts until the first four days of January of the following year.

This phenomenon is explained by the tax adjustment technique of financial intermediaries. Financial intermediaries usually sell in December and buy back in early January. In this way, financial intermediaries create a certain loss on capital at the end of the year to adjust the tax payable. The relevance of the year-end effect and the scale effect under the impact of tax adjustment lies in the fact that:

Small business securities are often held by small investors while financial intermediaries rarely hold these securities. Meanwhile, it is usually only financial intermediaries that have activities aimed at tax adjustment.

1.3.5.2. Weekend effect, holiday effect and month effect

Regarding the weekend effect, two hypotheses have been proposed:

+ Securities interest rates are proportional to the time of holding securities. Thus, after the weekend, securities interest rates will have to increase 3 times.

+ The stock interest rate depends on the auction time. Thus, the stock interest rate on the second day must be equal to the stock interest rate on the other days.

However, many other results show results contrary to the above two hypotheses. The results of Hamon and Jacquillat (1998) based on observations of daily opening prices at the Paris stock exchange during the period 1977 - 1987 showed that stock returns on Mondays were negative while on other days they were positive. French (1980) when examining closing prices found that stock returns were negative on Tuesdays, while on other days they were higher than the average of the week (according to [10]).

Regarding the weekend effect, the general conclusion is drawn based on the study of Rogalski (1984) mentioned in [14]. When determining the interest rate based on the opening and closing prices of each day, the interest rate of the second day is positive. But when comparing the closing price of the previous day with the opening price of the next day, the interest rate between the opening time of the second day and the closing time of the previous weekend is negative. Thus, after the weekend, stock prices generally decrease on the first day of the following week and then increase again.

Regarding the holiday effect, studies have shown that interest rates increase sharply when the market is back in operation compared to the pre-holiday period. Ariel (1985) statistically analyzed the interest rates of a portfolio of DJIA securities during the period 1963 - 1982 and found that the average increase after the holiday was 9 times that before the holiday. If the portfolio is structured according to the level of

capitalization, the average increase is up to 14 times. Lakonishok and Smidt (1978) when calculating over a 90-year period with DJIA stocks, the average increase is up to 21 times (0.219% per day compared to 0.0094% per day). This study also shows that 51% of the capital gain is achieved when investing in DJIA stocks in the 10-day period before the holiday (according to [10]).

The month effect is also worth noting. During the period 1966-1981, the interest rate on the US stock market calculated on the closing price of the first four days of the month compared to the previous month was 0.473%, while calculated on the closing price of the four consecutive days during the rest of the month was only 0.0612% (up to 7.7 times).

It is difficult to explain in detail the phenomena that create abnormal income corresponding to the above-mentioned tested effects. However, basically, the phenomena depend on the characteristics of capital flows in each market, the behavior of financial intermediaries and the disclosure of information. The concentration of securities trading registration at certain times will create the ability to predict capital flows and information will be reflected in prices at the corresponding major periods and the disclosure of information by enterprises also makes information appear, they will be reflected in prices, especially in the transitional period of months and years. It contributes significantly to the appearance of year-end effects and month effects.

All of the above effects give rise to abnormal returns, which undermine the hypothesis of market efficiency and confound empirical tests. Market efficiency assessments must clearly take into account the above effects in order to address them appropriately in research.

CHAPTER 1 SUMMARY

In summary, chapter 1 of the thesis has outlined the theoretical foundations of EMH, which are the concept of efficient markets, the mathematical basis of the theory, the meaning and importance of this theory... Research on EMH is mainly testing the efficiency of markets and specifically testing the three types of efficiency corresponding to the information sets reflected in the market, which is one of the tasks that EMH researchers continuously carry out. Identifying information sets is very important to develop testing models. The market is more efficient when the information is reflected in stock prices faster and vice versa. A more specific and in-depth analysis of the common testing methods of the three types of efficient markets, a summary of the testing results in some countries as well as an assessment of the efficiency of the Vietnamese stock market will be introduced in chapter 2 of the thesis.

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