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The Handbook of Equity Market Anomalies: Translating Market Inefficiencies into Effective Investment Strategies

Leonard Zacks (Editor)
ISBN: 978-0-470-90590-6
334 pages
October 2011
The Handbook of Equity Market Anomalies: Translating Market Inefficiencies into Effective Investment Strategies (0470905905) cover image
Investment pioneer Len Zacks presents the latest academic research on how to beat the market using equity anomalies

The Handbook of Equity Market Anomalies organizes and summarizes research carried out by hundreds of finance and accounting professors over the last twenty years to identify and measure equity market inefficiencies and provides self-directed individual investors with a framework for incorporating the results of this research into their own investment processes. Edited by Len Zacks, CEO of Zacks Investment Research, and written by leading professors who have performed groundbreaking research on specific anomalies, this book succinctly summarizes the most important anomalies that savvy investors have used for decades to beat the market.

Some of the anomalies addressed include the accrual anomaly, net stock anomalies, fundamental anomalies, estimate revisions, changes in and levels of broker recommendations, earnings-per-share surprises, insider trading, price momentum and technical analysis, value and size anomalies, and several seasonal anomalies. This reliable resource also provides insights on how to best use the various anomalies in both market neutral and in long investor portfolios. A treasure trove of investment research and wisdom, the book will save you literally thousands of hours by distilling the essence of twenty years of academic research into eleven clear chapters and providing the framework and conviction to develop market-beating strategies.

  • Strips the academic jargon from the research and highlights the actual returns generated by the anomalies, and documented in the academic literature
  • Provides a theoretical framework within which to understand the concepts of risk adjusted returns and market inefficiencies
  • Anomalies are selected by Len Zacks, a pioneer in the field of investing

As the founder of Zacks Investment Research, Len Zacks pioneered the concept of the earnings-per-share surprise in 1982 and developed the Zacks Rank, one of the first anomaly-based stock selection tools. Today, his firm manages U.S. equities for individual and institutional investors and provides investment software and investment data to all types of investors. Now, with his new book, he shows you what it takes to build a quant process to outperform an index based on academically documented market inefficiencies and anomalies.

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Preface xi

Acknowledgments xvii

CHAPTER 1 Conceptual Foundations of Capital Market Anomalies 1
Mozaffar Khan

Efficient Markets 2

Identifying Anomalies in Capital Markets 3

Explaining Anomalies 5

Anomalies: Weighing the Evidence 10

Appendix 1.1: Risk and Expected-Return Models 10

References 17

CHAPTER 2 The Accrual Anomaly 23
Patricia M. Dechow, Natalya V. Khimich, and Richard G. Sloan

What Are Accruals? 24

Sloan (1996) in a Nutshell 32

Extensions of Sloan (1996) 38

Alternative Explanations for the Accrual Anomaly 45

Practical Implications 51

Appendix 2.1: Estimation and Testing Framework Used in Sloan (1996) 52

Appendix 2.2: Details on the Broader Definition of Accruals 54

References 59

CHAPTER 3 The Analyst Recommendation and Earnings Forecast Anomaly 63
George Serafeim

Role of Research Analysts 63

Investment Recommendations 64

Earnings Forecast Revisions 73

Determinants of Forecast Revisions 76

International Evidence 78

Overview of the Investment Performance of Forecast Revisions 79

Appendix 3.1: Details of Returns to Recommendation Strategies 79

References 87

CHAPTER 4 Post-Earnings Announcement Drift and Related Anomalies 91
Daniel Taylor

The Basics of the Anomaly 92

Measuring Earnings Surprises 99

Sources of Post-Earnings Announcement Drift 102

Extensions 106

Institutional Investors 108

Individual Investors 110

References 112

CHAPTER 5 Fundamental Data Anomalies 117
Ian Gow

Fundamental Metrics 118

Distress Risk 122

Capital Investment and Growth Anomalies 123

International Evidence 125

Conclusion 126

References 126

CHAPTER 6 Net Stock Anomalies 129
Daniel Cohen, Thomas Lys, and Tzachi Zach

Initial Public Offerings 130

Seasoned Equity Offerings 132

Debt Issuances 133

Share Repurchases and Tender Offers 134

Dividend Initiation and Omissions 136

Private Equity Placement 138

Overall Net External Financing 138

Mergers and Acquisitions 141

International Evidence 142

Other Explanations for the Abnormal Returns 143

References 144

CHAPTER 7 The Insider Trading Anomaly 147
Ian Dogan

Overview of Insider Filings 148

Documentation of the Anomaly 148

Results for the 1978–2005 Period 150

How Consistent Is the Anomaly Year by Year? 152

When Are Returns Generated during the 1-Year Holding Periods? 154

Returns in Small Cap versus Large Cap 155

Does It Work on the Short Side? 156

Do Returns Vary by Industry? 160

Institutional Investors 162

Individual Investors 162

Relation to Other Anomalies 163

International Evidence 164

Can Insider Data Predict S&P 500 Returns? 165

Latest Developments 166

Long/Short Strategy for Institutional Investors 167

References 170

CHAPTER 8 Momentum: The Technical Analysis Anomaly 173
Lee M. Dunham

History of Technical Analysis and Momentum 176

Assessing Momentum and Reversal

in Stock Prices 178

Early Influential Work on Momentum

and Reversals 179

Improving Upon Momentum Strategies 184

Moving Averages 186

52-Week High/Low 187

Momentum at Industry Levels 188

Momentum and Mutual Funds 189

Is Technical Analysis Profitable? 190

Institutional Investors 193

Explanations for Momentum and Reversals 195

International Evidence 198

References 200

CHAPTER 9 Seasonal Anomalies 205
Constantine Dzhabarov and William T. Ziemba

January Effect 206

The January Barometer 213

Sell-in-May-and-Go-Away 221

Holiday Effects 226

Day-of-the-Week Effects 231

Seasonality Calendars 234

Political Effects 237

Turn-of-the-Month Effects 248

Open/Close Daily Trade on the Open 254

Weather: Sun, Rain, Snow, Moon, and the Stars 255

Conclusions and Final Remarks 256

References 256

CHAPTER 10 Size and Value Anomalies 265
Oleg A. Rytchkov

The Early Days 265

Fama-French Three-Factor Model 266

Value Anomaly: Risk or Mispricing? 267

Alternative Value Indicators 269

Time Variation in the Value Premium 270

Cross-Sectional Variation in the Value Premium 273

Anatomy of the Size Anomaly 275

International Evidence 278

Value Premium: Evidence from Alternative Asset Classes 279

References 281

CHAPTER 11 Anomaly-Based Processes for the Individual Investor 285
Leonard Zacks

Increasing Returns Using Market Neutral 286

Using ETFs to Add a Market Neutral Asset to a Portfolio 291

Using Stock Scoring Systems to Outperform Indexes 292

Implementation of Anomaly-Based Quant Processes 296

End of the Tour 305

References 305

APPENDIX Use of Anomaly Research by Professional Investors 307

From Academia to Wall Street 307

Statistical Arbitrage 308

High-Frequency Trading 309

Multifactor Models 309

Assets in Market Neutral Portfolios 310

Assets in Long Portfolios 311

United States versus International 313

References 314

About the Contributors 317

Index 323

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Leonard Zacks has been Chairman and CEO of Zacks Investment Research since 1978. Prior to that, he held several positions with A.G. Becker, a Chicago-based brokerage firm, including investment analyst, assistant to the president, and product development manager. Zacks was an associate at McKinsey & Company in New York and an analyst at the Rand Corporation in California. He holds a PhD in operations research from the Massachusetts Institute of Technology.
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