Question

to write (min 2 pages) about Financial anomalies and momentum

1. define each term (in details)

2. differentiate between anomalies and momentum

3. discuss causes of each one

4. give at least two examples on each one

5. clarify if investors can achieve abnormal return when anomalies or momentum exist and how

6. cite your work

Answer 1

Answer- 1. Financial Anomalies- Financial market anomalies are cross-sectional and time series patterns in security returns that are not predicted by a central paradigm or theory. In Finance, an anomaly is when the actual result under a given set of assumptions is different from the expected result predicted by a model. An anomaly provides evidence that a given assumption or model does not hold up in practice. The model can either be a relatively new or older model. In finance, two common types of anomalies are market anomalies and pricing anomalies.

Market anomalies are distortions in returns that contradict the efficient market hypothesis (EMH). Pricing anomalies are when something, for example a stock, is priced differently to how a model predicts it will be priced.

Momentum- In finance, momentum is the empirically observed tendency for rising asset prices to rise further, and falling prices to keep falling. Momentum is the rate of acceleration of a security's price or volume—that is, the speed at which the price is changing. Simply put, it refers to the rate of change on price movements for a particular asset and is usually defined as a rate. In technical analysis, momentum is considered an oscillator and is used to help identify trends.

2.

Anomaly	Momentum
1. Existence of momentum is a market anomaly.	1. It is an observed tendency for rising asset prices to rise further and falling prices to keep falling.
2. Most market anomalies are psychologically driven.	2. Momentum is trend driven.
3. Anomalies, however, tend to quickly disappear once knowledge about them has been made public.	3. Momentum trading happens on the backs of others and price trends are never guaranteed.
4. Anomalies do tend to be few and far between	4. Momentum is the rate of acceleration of a security's price or volume.

3. Causes of Financial Anomalies: Due to the timely actions of investors prices of stocks quickly adjust to the new information, and reflect all the available information. So no investor can beat the market by generating abnormal returns.The functioning of these stock markets deviate from the rules of EMH. Due to these deviations anomaly occurs.

Causes of Momentum: Behavioural analysts believe that investors often sell stocks too quickly on good news to lock-in profits while selling too slowly on bad news in the hope that the price may rebound. This causes momentum.

4. Examples of Financial Anomalies: (i) The January effect is a rather well-known anomaly. Here, the idea is that stocks that underperformed in the fourth quarter of the prior year tend to outperform the markets in January. The reason for the January effect is so logical that it is almost hard to call it an anomaly. Investors will often look to jettison underperforming stocks late in the year so that they can use their losses to offset capital gains taxes (or to take the small deduction that the IRS allows if there is a net capital loss for the year). Many people call this event "tax-loss harvesting."

(ii) The September effect refers to historically weak stock market returns for the month of September. There is a statistical case for the September effect depending on the period analyzed, but much of the theory is anecdotal. It is generally believed that investors return from summer vacation in September ready to lock in gains as well as tax losses before the end of the year. There is also a belief that individual investors liquidate stocks going into September to offset schooling costs for children. As with many other calendar effects, the September effect is considered a historical quirk in the data rather than an effect with any causal relationship.

Examples of Momentum: (i) Assume a company had earnings per share of $1 last year, $0.50 the year prior, and $0.25 the year before that. For the last two years, the company has increased earnings by 100%. If next year they increase earnings to $3, earnings momentum is accelerating up to 200%. If this growth hasn't been already priced in, this could drive up the price of the stock.

5. Investors can obtain abnormal return based on certain investment strategies in anomaly observed markets. The strategy of momentum investing says simply to buy stocks that are rising in value and sell those that are falling. Abnormal returns should be crowded-out, but have somehow remained remarkably persistent.