Errors in recorded security prices and the turn-of-the year effect

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ERRORS IN RECORDED SECURITY PRICES AND THE TURN-OF-THE-YEAR EFFECT

The turn-of-the-year (TOY) effect (or January effect) refers to the anomalous
behavior of stock returns during the last five trading days in December and
the first five trading days in January. This anomaly is of particular inter-
est to financial researchers because it appears to be a small-firm effect and
the source of the majority of size-related anomalies (see [16], [21], [23],
[24]). The interest in the TOY effect is justified because of its implica-
tions concerning the validity of the Capital Asset Pricing Model (CAPM) and
market efficiency.

In this paper we show that the TOY effect is a low-priced security effect
where size proxies for share price. It is an errors-in-variables problem due
to the use of the one-eighth pricing convention in recording security prices.
This explanation of the TOY effect is consistent with both the CAPM and market
efficiency.

Section I of the paper discusses possible sources of errors in recorded
security prices. Section II looks at recorded-price errors as a source of
bias in stock returns and as a source of specification error in the market
model. Section III outlines the hypothesis that the TOY effect is a low-
priced security effect. Sections IV and V present the data and the test of
the low-priced security hypothesis. The paper's conclusions are presented in
Section VI.

I. Sources of Price-Related Errors in Recorded Security Prices

The use of the one-eighth pricing convention in recording stock prices results
in measurement errors in observed stock prices. The relative size of the

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