Are Extreme Returns Determinants of Cross-sectional Expected Stock Returns? MAX effect in the Finnish market
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School of Business |
Master's thesis
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Authors
Date
2018
Department
Major/Subject
Mcode
Degree programme
Finance
Language
en
Pages
29+3
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Abstract
I investigate a recently proposed asset pricing anomaly MAX effect, i.e. the extreme positive returns in the previous month, in the cross-sectional pricing of stocks in Finland. The results confirm that there exists significant negative MAX effect in the Finnish market. The equal-weighted return difference between high-MAX and low-MAX portfolios is −1.11% per month, with corresponding alpha spread of −0.16%. Both values are statistically significant at 5% level. However, the negative MAX effect is not robust for value-weighted portfolios. These results are consistent with previous research that the negative MAX effect in the European stock market is concentrated in small-sized companies. I conducted bivariate sorting analysis and firm-level cross-sectional regression, and conclude that the negative MAX effect is significant after controlling for size, value, skewness, momentum, short-term reversal and idiosyncratic volatility. Moreover, I discussed the relationship between the MAX effect and idiosyncratic volatility effect (IV). While both MAX and IV are negatively related to the expected future returns, MAX is not a substitute for IV. However, I did not observe a positive idiosyncratic volatility effect in the Finnish stock market after controlling for MAX, as Bali et al. (2011) recorded in their study.Description
Thesis advisor
Jylhä, PetriKeywords
MAX effect, extreme return, lottery-type stocks, cross-sectional stock returns