Alternative behavioral explanations for the MAX effect: Evidence from Finland
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School of Business |
Master's thesis
Authors
Date
2024
Department
Major/Subject
Mcode
Degree programme
Finance
Language
en
Pages
61
Series
Abstract
The MAX effect refers to the tendency of stocks with high single-day returns during the prior month to produce weak returns in the subsequent month. Initially attributed to investor preference for lottery-like assets, more recent literature proposes alternative behavioral explanations for the phenomenon such as overreaction to new information and anchoring bias. This thesis explores these explanations in Finland, focusing on the impact of earnings announcements and the nearness of price to the 52-week high on the MAX effect. The study finds that the MAX effect disappears when only considering returns stemming from earnings announcements, and when stocks are priced near 52-week highs. Furthermore, the research reveals that idiosyncratic volatility almost entirely explains the MAX effect in Finland. Controlling for idiosyncratic volatility reduces the four-factor alpha of the MAX effect by 96.1%. Also, unlike MAX, idiosyncratic volatility can predict returns beyond the subsequent month. These findings challenge previous conclusions about the MAX effect in Finland and provide strong evidence against the lottery preference explanation.Description
Thesis advisor
Suominen, MattiKeywords
MAX effect, anomalies, behavioral bias, idiosyncratic volatility