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strategy.The small-firm turn-of-the-year effect became weaker in the years after it was firstdocumented in the academic literature, although there is some evidence that it stillexists. Interestingly, however, it does not seem to exist in the portfolio returns ofpractitioners who focus on small-capitalization firms.Likewise, the evidence that stock market returns are predictable using variables suchas dividend yields or inflation is much weaker in the periods after the papers that
documented these findings were published.
All of these findings raise the possibility that anomalies are more apparent thanreal. The notoriety associated with the findings of unusual evidence tempts authorsto further investigate puzzling anomalies and later to try to explain them. But eveif the anomalies existed in the sample period in which they were first identified, theactivities of practitioners who implement strategies to take advantage of anomalous
behavior can cause the anomalies to disappear (as research findings cause the marketto become more efficient).
Keywords:market efficiency, anomaly, size effect, value effect, selection bias, momentum
1. Introduction
Anomalies are empirical results that seem to be inconsistent with maintained theoriesof asset-pricing behavior. They indicate either market inefficiency (profit opportunities)or inadequacies in the underlying asset-pricing model. After they are documented and
analyzed in the academic literature, anomalies often seem to disappear, reverse, orattenuate. This raises the question of whether profit opportunities existed in the past,but have since been arbitraged away, or whether the anomalies were simply statisticalaberrations that attracted the attention of academics and practitioners.Surveys of the efficient markets literature date back at least to Fama (1970), and
there are several recent updates, including Fama (1991) and Keim and Ziemba (2000),that stress particular areas of the finance literature. By their nature, surveys reflectthe views and perspectives of their authors, and this one will be no exception. Mygoal is to highlight some interesting findings that have emerged from the research of
many people and to raise questions about the implications of these findings for theway academics and practitioners use financial theory 1.
There are obvious connections between this chapter and other chapters by Ritter (5:Investment Banking and Security Issuance), Stoll (9: Market Microstructure), Dybvigand Ross (10: Arbitrage, State Prices and Portfolio Theory), Duffie (11: IntertemporalAsset Pricing Models), Ferson (12: Tests of Multi-Factor Pricing Models, Volatility,
and Portfolio Performance), Campbell (13: Equilibrium Asset Pricing Models), Easley
and O’Hara (17: Asset Prices Market Microstructure) and Barberis and Thaler (18:Behavioral Issues in Asset Pricing). In fact, those chapters draw on some of the samefindings and papers that provide the basis for my conclusions.At a fundamental level, anomalies can only be defined relative to a model of“normal” return behavior. Fama (1970) noted this fact early on, pointing out thattests of market efficiency also jointly test a maintained hypo
thesis about equilibrium
expected asset returns. Thus, whenever someone concludes that a findingseems toindicate market inefficiency, it may also be evidence that the underlying asset-pricingmodel is inadequate.
It is also important to consider the economic relevance of a presumed
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